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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, 2000
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.)
8401 N CENTRAL EXPRESSWAY, SUITE 800, DALLAS, TX 75225
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 874-2323
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) 44,964,921 as of May 5, 2000
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CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2000
INDEX
PART I. -- FINANCIAL INFORMATION
PAGE
----
ITEM 1. Financial Statements
Consolidated Balance Sheet -- March 31, 2000 and December 31, 1999..................................... 3
Consolidated Statement of Operations -- Quarter Ended March 31, 2000 and 1999.......................... 4
Consolidated Statement of Cash Flows -- Quarter Ended March 31, 2000 and 1999.......................... 5
Notes to Consolidated Financial Statements............................................................. 6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.................................................. 15
ITEM 3. Qualitative and Quantitative Disclosure of Market Risk.......................................... 25
PART II. -- OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K................................................................ 25
SIGNATURES.............................................................................................. 26
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PART I. -- FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ITEM 1. FINANCIAL STATEMENTS
MARCH 31, 2000 DECEMBER 31, 1999
-------------- -----------------
(UNAUDITED)
ASSETS
Mortgage securities and other investments $ 5,339,935 $ 5,408,714
CMO collateral and investments 3,455,238 3,318,886
------------ ------------
8,795,173 8,727,600
Prepaids, receivables and other 46,205 48,451
Restricted cash and cash equivalents 2,500 2,500
Cash and cash equivalents 9,389 28,488
------------ ------------
$ 8,853,267 $ 8,807,039
============ ============
LIABILITIES
Borrowings under repurchase arrangements $ 4,855,340 $ 4,872,392
Collateralized mortgage obligations 3,427,653 3,289,584
Accounts payable and accrued expenses 18,100 30,673
------------ ------------
8,301,093 8,192,649
------------ ------------
PREFERRED STOCK SUBJECT TO REPURCHASE
$0.10 par value; 10,756 shares authorized, issued and
outstanding ($52,735 aggregate repurchase amount) 50,458 50,584
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value;
89,244 shares authorized:
$1.60 Cumulative Preferred Stock, Series A,
374 and 374 shares issued and outstanding
($6,134 aggregate liquidation preference) 5,230 5,228
$1.26 Cumulative Convertible Preferred Stock, Series B,
16,428 and 16,673 shares issued and outstanding
($186,951 aggregate liquidation preference) 183,503 186,248
Common stock - $0.01 par value; 100,000 shares authorized;
45,358 and 56,856 shares issued and outstanding 454 569
Paid-in capital 716,700 769,617
Accumulated deficit (299,174) (304,568)
Accumulated other comprehensive loss (104,997) (93,288)
------------ ------------
501,716 563,806
------------ ------------
$ 8,853,267 $ 8,807,039
============ ============
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
QUARTER ENDED MARCH 31
----------------------------
2000 1999
------------ ------------
INTEREST INCOME:
Mortgage securities and other investments $ 84,900 $ 47,312
CMO collateral and investments 57,929 77,030
------------ ------------
Total interest income 142,829 124,342
------------ ------------
INTEREST AND RELATED EXPENSE:
Borrowings under repurchase arrangements 71,908 33,914
Collateralized mortgage obligations 57,903 77,517
Mortgage insurance and other
403 627
------------ ------------
Total interest and related expense 130,214 112,058
------------ ------------
Net margin on mortgage assets and other investments 12,615 12,284
------------ ------------
OTHER OPERATING REVENUE (EXPENSE):
Gain on sale of mortgage assets and related derivative
financial instruments -- 1,738
CMO administration and other 784 1,470
Other operating expense (1,729) (1,585)
------------ ------------
Total other operating revenue (expense) (945) 1,623
------------ ------------
NET INCOME $ 11,670 $ 13,907
============ ============
Net income $ 11,670 $ 13,907
Less cash dividends on preferred shares (6,271) (5,684)
------------ ------------
Net income available to common stockholders $ 5,399 $ 8,223
============ ============
NET INCOME PER COMMON SHARE:
Basic $ 0.11 $ 0.14
Diluted 0.11 0.14
CASH DIVIDENDS PAID PER SHARE:
Common $ 0.120 $ --
Series A Preferred 0.400 0.400
Series B Preferred 0.315 0.315
Series C Preferred 0.140 --
Series D Preferred 0.100 --
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
QUARTER ENDED MARCH 31
---------------------------
2000 1999
------------ ------------
OPERATING ACTIVITIES:
Net income $ 11,670 $ 13,907
Noncash items:
Amortization of discount and premium 5,295 11,409
Depreciation and other amortization 205 286
Loss (gain) on sale of mortgage assets and derivative financial instruments -- (1,738)
Net change in prepaids, receivables, other assets, accounts payable
and accrued expenses (10,307) (31,912)
------------ ------------
Net cash provided (used) by operating activities 6,863 (8,048)
------------ ------------
INVESTING ACTIVITIES:
Purchases of mortgage securities and other investments (137,376) (3,319,728)
Purchases of CMO collateral (232,358) --
Principal collections on mortgage investments 191,758 295,380
Proceeds from sales of mortgage assets -- 114,763
Proceeds from sales and settlement of derivative financial instruments -- 12,595
CMO collateral:
Principal collections 95,168 404,123
Decrease in accrued interest receivable 576 3,607
Decrease in short-term investments 254 11,116
------------ ------------
Net cash used by investing activities (81,978) (2,478,144)
------------ ------------
FINANCING ACTIVITIES:
Increase (decrease) in short-term borrowings (17,052) 2,962,331
Collateralized mortgage obligations:
Issuance of securities 232,358 --
Principal payments on securities (96,604) (521,551)
Decrease in accrued interest payable (509) (3,635)
Capital stock transactions (55,516) (10,629)
Dividends paid (6,661) (5,684)
------------ ------------
Net cash provided by financing activities 56,016 2,420,832
------------ ------------
Net change in cash and cash equivalents (19,099) (65,360)
Cash and cash equivalents at beginning of period 28,488 73,385
------------ ------------
Cash and cash equivalents at end of period $ 9,389 $ 8,025
============ ============
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
(UNAUDITED)
NOTE 1 -- BUSINESS
Capstead Mortgage Corporation, a mortgage investment firm, earns income from
investing in mortgage assets on a leveraged basis and from other investment
strategies.
Election Of New Leadership. At the Company's Annual Meeting of Stockholders held
April 20, 2000, stockholders elected a new Board of Directors including Wesley
R. Edens, chairman of the board of Fortress Investment Group LLC ("Fortress").
An affiliate of Fortress acquired the Company's Series C and D preferred shares
in December 1999. The composition of the new Board of Directors now includes
four members designated by Fortress and three members designated by Capstead,
two of whom are continuing directors from the previous Board. In addition, the
Board announced the appointment of Mr. Edens to the positions of Chairman of the
Board and Chief Executive Officer of the Company and Ronn K. Lytle, the
Company's previous chairman and chief executive, to the position of Vice
Chairman of the Board.
Adoption Of New Investment Strategy. During 1999 the Company's primary focus
consisted of managing a portfolio of single-family residential mortgage-backed
securities issued by government-sponsored entities, either Fannie Mae, Freddie
Mac or Ginnie Mae ("Agency Securities"). On April 20, 2000 the Board approved
modifying the Company's investment strategy to focus on short maturity and
adjustable-rate assets, including but not limited to, credit-sensitive
commercial and residential mortgage-backed securities and ARM Agency Securities.
In connection with this modification, the Company intends to dispose of
approximately $1.0 billion of its fixed-rate mortgage investments and
approximately $1.1 billion of its medium-term and ARM securities. As a result,
the Company anticipates recognizing a second quarter loss on the sale of these
securities of $85 million to $90 million, all of which is already reflected in
book value per share at March 31, 2000. Most of these sales are expected to be
completed by year-end. Pending final sale, these securities will be classified
as trading securities and further changes in market value, if any, will be
reflected in operating results. Capital made available because of these sales is
expected to be redeployed over the next several quarters into suitable
investments in keeping with the new investment strategy.
NOTE 2 -- BASIS OF PRESENTATION AND 1-FOR-2 REVERSE COMMON STOCK SPLIT
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, 2000 are not necessarily indicative of the results that may be
expected for the calendar year ending December 31, 2000. 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, 1999.
1-For-2 Reverse Common Stock Split. At the Company's Annual Meeting,
stockholders approved a 1-for-2 reverse split of the common stock. Accordingly,
the Board of Directors has established the close
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of business on May 8, 2000 as the effective date for the reverse split. The
first day the common shares will trade post-split will be May 9, 2000. The
reverse split will reduce the number of outstanding common shares to
approximately 22.5 million. Concurrent with the reverse split, the conversion
ratio for each series of preferred stock, representing the number of common
shares issuable upon conversion of each preferred share, will be adjusted as
follows:
PRE- POST-
REVERSE SPLIT REVERSE SPLIT
PREFERRED SERIES RATIO RATIO
---------------- --------------- --------------
A 2.1707 1.0854
B 0.7537 0.3769
C 1.000 0.5000
D 1.000 0.5000
These consolidated financial statements and related notes have not been adjusted
to reflect the reverse common stock split.
NOTE 3 -- SHARE REPURCHASES AND DECLARATION OF COMMON STOCK DIVIDEND
During the first quarter, the Company acquired, through open market purchases,
360,500 common shares at an average price of $3.88 (including transaction costs)
and 245,800 shares of its Series B preferred shares at an average price of $9.59
(including transaction costs). On January 25, 2000 the Company purchased
11,137,000 common shares at a price of $4.64 per share (including transaction
costs) pursuant to a tender offer that closed on January 14, 2000. Since share
repurchases began in December 1998 through April 24, 2000, the Company has
repurchased 26.9 percent of its outstanding common shares and 5.5 percent of its
Series B preferred shares. As of April 24, 2000, the Company had remaining
authorization to repurchase 1.6 million common shares and 1.1 million Series B
preferred shares.
On April 20, 2000 the Board of Directors declared a first quarter dividend of 11
cents per common share, payable May 19 to stockholders of record as of May 5,
2000.
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NOTE 4 -- NET INCOME PER COMMON SHARE
Basic net income per common share is computed by dividing net income after
deducting preferred share dividends* by the weighted average number of common
shares outstanding. Diluted net income per common share is computed by dividing
net income, after deducting preferred share dividends for dilutive convertible
preferred shares, by the weighted average number of common shares, dilutive
stock options and dilutive convertible preferred shares outstanding. The
components of the computation of basic and diluted net income per share for the
periods indicated are as follows (in thousands, except per share data):
QUARTER ENDED MARCH 31
------------------------------
2000 1999
------------- -------------
NUMERATOR FOR BASIC NET INCOME PER COMMON SHARE:
Net income $ 11,670 $ 13,907
Less all preferred share dividends* (6,271) (5,684)
------------- -------------
Net income available to common stockholders $ 5,399 $ 8,223
============= =============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 48,633 60,138
============= =============
BASIC NET INCOME PER COMMON SHARE $ 0.11 $ 0.14
============= =============
NUMERATOR FOR DILUTED NET INCOME PER COMMON SHARE:
Net income $ 11,670 $ 13,907
Less cash dividends paid on antidilutive convertible preferred shares:
Series A (150) (150)
Series B (5,221) (5,437)
Series B repurchase amounts less than (in excess of) book value* 390 (97)
Series C (753) **
Series D (dilutive) ** **
------------- -------------
$ 5,936 $ 8,223
============= =============
DENOMINATOR FOR DILUTED NET INCOME PER COMMON SHARE:
Weighted average common shares outstanding 48,633 60,138
Net effect of dilutive stock options 21 20
Net effect of dilutive preferred shares 5,378 **
------------- -------------
54,032 60,158
============= =============
DILUTED NET INCOME PER COMMON SHARE $ 0.11 $ 0.14
============= =============
* Included as a component of the Series B preferred share dividends in the
calculation of both basic and diluted net income per common share, is the
difference between repurchase amounts and the Series B preferred shares
book value of $11.17 per share.
** Not applicable.
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NOTE 5 -- MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities investments and the related average effective interest rates
(calculated for the quarter then ended including mortgage insurance costs on
non-agency securities and excluding unrealized gains and losses) were as follows
(dollars in thousands):
PURCHASE AVERAGE
PRINCIPAL PREMIUMS CARRYING AVERAGE EFFECTIVE
BALANCE (DISCOUNTS) BASIS AMOUNT COUPON RATE
------------- ------------- ------------- ------------- ------------- -------------
MARCH 31, 2000 * ** **
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 1,046,619 $ (2,811) $ 1,043,808 $ 984,168 6.18% 6.21%
Medium-term 1,073,660 3,930 1,077,590 1,048,598 6.15 5.94
ARMs:
LIBOR/CMT 901,947 19,681 921,628 926,087 7.28 6.38
COFI 234,365 1,502 235,867 228,214 6.06 5.76
GNMA ARMs 1,878,665 24,437 1,903,102 1,887,680 6.44 6.06
------------- ------------- ------------- ------------- ------------- -------------
5,135,256 46,739 5,181,995 5,074,747 6.45 6.11
Non-agency securities 187,518 362 187,880 189,489 7.98 7.92
CMBS - adjustable-rate 76,175 (986) 75,189 75,699 7.97 8.59
------------- ------------- ------------- ------------- ------------- -------------
$ 5,398,949 $ 46,115 $ 5,445,064 $ 5,339,935 6.53% 6.20%
============= ============= ============= ============= ============= =============
DECEMBER 31, 1999
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 1,063,822 $ (2,924) $ 1,060,898 $ 1,009,577 6.18% 6.23%
Medium-term 1,123,984 4,516 1,128,500 1,103,704 6.15 5.89
ARMs:
LIBOR/CMT 911,262 20,824 932,086 935,291 7.03 5.63
COFI 242,573 1,570 244,143 237,721 5.84 5.62
GNMA ARMs 1,924,659 26,083 1,950,742 1,936,032 6.29 5.65
------------- ------------- ------------- ------------- ------------- -------------
5,266,300 50,069 5,316,369 5,222,325 6.35 5.81
Non-agency securities 126,431 385 126,816 127,059 8.34 8.06
CMBS - adjustable-rate 60,182 (852) 59,330 59,330 7.54 8.53
------------- ------------- ------------- ------------- ------------- -------------
$ 5,452,913 $ 49,602 $ 5,502,515 $ 5,408,714 6.41% 5.87%
============= ============= ============= ============= ============= =============
* Includes mark to market, if applicable (see NOTE 8).
** Average Coupon is calculated as of the indicated balance sheet date.
Average Effective Rate is calculated for the quarter then ended.
The Company classifies its Agency Securities and non-agency securities by
interest rate characteristics of the underlying single-family residential
mortgage loans. Commercial mortgage-backed securities ("CMBS") are classified in
a similar fashion. Fixed-rate mortgage securities either (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 securities either (i) have 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, (ii) have initial
interest rates that adjust one time, approximately 5 years following origination
of the mortgage loan, based on a specified margin over Fannie Mae yields for
30-year, fixed-rate commitments at the time of adjustment, or (iii) are
fixed-rate mortgage securities that have expected weighted average lives of 5
years or less. Adjustable-rate mortgage ("ARM") securities either (i) adjust
semiannually based on a specified
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margin over the 6-month London Interbank Offered Rate ("LIBOR"), (ii) adjust
annually based on a specified margin over 1-year Treasuries ("CMT"), (iii)
adjust monthly based on a specific margin over the Cost of Funds Index as
published by the Eleventh District Federal Reserve Bank ("COFI"), (iv) were
previously classified as medium-term and have begun adjusting annually based on
a specified margin over 1-year Treasuries, or (v) in the case of CMBS held as of
March 31, 2000, adjust monthly based on a specified margin over 30-day LIBOR.
Agency Securities have no foreclosure risk. Non-agency securities consist of
private mortgage pass-through securities backed primarily by single-family
jumbo-sized residential mortgage loans whereby the related credit risk of the
underlying loans is borne by AAA-rated private mortgage insurers, and other
AAA-rated private mortgage securities (together, "Non-agency Securities").
Although investment grade when acquired, CMBS held by the Company at March 31,
2000 carry credit risk associated with the underlying commercial mortgage loans.
Features of the related CMBS issuance, including subordinated securities held by
other investors, help mitigate this risk. The maturity of mortgage-backed
securities is directly affected by the rate of principal prepayments on the
underlying loans.
NOTE 6 -- CMO COLLATERAL AND INVESTMENTS
CMO collateral consists of fixed-rate, medium-term and adjustable-rate mortgage
securities collateralized by single-family residential mortgage loans and
related short-term investments, both pledged to secure CMO borrowings ("Pledged
CMO Collateral"). All principal and interest on pledged mortgage securities is
remitted directly to collection accounts maintained by a trustee. The trustee is
responsible for reinvesting those funds in short-term investments. All
collections on the pledged mortgage securities and the reinvestment income
earned thereon are available for the payment of principal and interest on CMO
borrowings. Pledged mortgage securities are private mortgage pass-through
securities whereby the related credit risk of the underlying loans is borne by
AAA-rated private mortgage insurers or subordinated bonds within the related CMO
series to which the collateral is pledged. The Company has retained $1.0 million
of credit risk in the form of subordinated bonds associated with approximately
$566 million of Pledged CMO Collateral remaining outstanding as of March 31,
2000. The weighted average effective interest rate for total Pledged CMO
Collateral was 7.07 percent during the quarter ended March 31, 2000.
CMO investments currently consist of reserve funds retained by the Company in
connection with two 1993 mortgage loan sales. These reserve funds are available
to pay special hazard (e.g. earthquake or mudslide-related losses) or certain
bankruptcy costs associated with approximately $141 million of loans remaining
outstanding as of March 31, 2000 from the related securitizations.
The components of CMO collateral and investments are summarized as follows (in
thousands):
MARCH 31, 2000 DECEMBER 31, 1999
-------------- -----------------
Pledged CMO Collateral:
Pledged mortgage securities $ 3,418,770 $ 3,283,848
Short-term investments 505 760
Accrued interest receivable 20,803 19,461
-------------- --------------
3,440,078 3,304,069
Unamortized premium 11,967 11,633
-------------- --------------
3,452,045 3,315,702
CMO investments 3,193 3,184
-------------- --------------
$ 3,455,238 $ 3,318,886
============== ==============
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NOTE 7 -- COLLATERALIZED MORTGAGE OBLIGATIONS
Each series of CMOs issued consists of various classes of bonds, most of which
have fixed rates of interest. Interest is payable monthly or quarterly at
specified rates for all classes. Typically, principal payments on each series
are made to each class in the order of their stated maturities so that no
payment of principal will be made on any class of bonds until all classes having
an earlier stated maturity have been paid in full. The components of CMOs along
with selected other information are summarized as follows (dollars in
thousands):
MARCH 31, 2000 DECEMBER 31, 1999
-------------- -----------------
CMOs $ 3,416,672 $ 3,281,464
Accrued interest payable 19,504 18,096
------------- -------------
Total obligation 3,436,176 3,299,560
Unamortized discount (8,523) (9,976)
------------- -------------
$ 3,427,653 $ 3,289,584
============= =============
Range of average interest rates 5.08% to 9.98% 5.13% to 9.45%
Range of stated maturities 2008 to 2030 2008 to 2028
Number of series 25 24
The maturity of each CMO series is directly affected by the rate of principal
prepayments on the related Pledged CMO Collateral. Each series is also subject
to redemption, generally at the Company's option, provided that certain
requirements specified in the related indenture have been met (referred to as
"Clean-up Calls"); therefore, the actual maturity of any series is likely to
occur earlier than its stated maturity. The average effective interest rate for
all CMOs was 7.13 percent during the quarter ended March 31, 2000.
NOTE 8 -- 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 value of Agency Securities, Non-agency Securities, CMBS and CMO
investments were estimated using either (i) quoted market prices when available,
including quotes made by lenders in connection with designating collateral for
repurchase arrangements, or (ii) offer prices for similar assets or market
positions. The fair value of Pledged CMO Collateral was based on projected cash
flows, after payment on the related CMOs, determined using market discount rates
and prepayment assumptions. The maturity of mortgage assets is directly affected
by the rate of principal payments on the underlying mortgage loans and, for
Pledged CMO Collateral, Clean-up Calls of the remaining CMOs outstanding.
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The following table summarizes fair value disclosures for available-for-sale
debt securities (in thousands):
GROSS GROSS
UNREALIZED UNREALIZED FAIR
BASIS GAINS LOSSES VALUE
------------ ------------ ------------ ------------
AS OF MARCH 31, 2000
Mortgage investments:
Agency Securities:
Fixed-rate $ 1,043,808 $ 245 $ 59,885 $ 984,168
Medium-term 1,077,590 -- 28,992 1,048,598
Adjustable-rate 3,060,597 6,191 24,807 3,041,981
Non-agency Securities 95,221 1,609 -- 96,830
CMBS - adjustable-rate 75,189 517 7 75,699
CMO collateral and investments 94,958 454 322 95,090
------------ ------------ ------------ ------------
$ 5,447,363 $ 9,016 $ 114,013 $ 5,342,366
============ ============ ============ ============
AS OF DECEMBER 31, 1999 Mortgage investments:
Agency Securities:
Fixed-rate $ 1,060,898 $ 268 $ 51,589 $ 1,009,577
Medium-term 1,128,500 39 24,835 1,103,704
Adjustable-rate 3,126,971 4,659 22,586 3,109,044
Non-agency Securities 28,817 249 6 29,060
CMBS - adjustable-rate 59,330 -- -- 59,330
CMO collateral and investments 103,142 697 184 103,655
------------ ------------ ------------ ------------
$ 5,507,658 $ 5,912 $ 99,200 $ 5,414,370
============ ============ ============ ============
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 Non-agency Securities. The following table summarizes fair value
disclosures for debt securities held-to-maturity (in thousands):
GROSS GROSS
UNREALIZED UNREALIZED FAIR
BASIS GAINS LOSSES VALUE
------------ ------------ ------------ ------------
AS OF MARCH 31, 2000
Non-agency Securities $ 92,659 $ 1,321 $ -- $ 93,980
Pledged CMO Collateral 3,360,148 1,395 17,368 3,344,175
------------ ------------ ------------ ------------
$ 3,452,807 $ 2,716 $ 17,368 $ 3,438,155
============ ============ ============ ============
AS OF DECEMBER 31, 1999
Non-agency Securities $ 97,999 $ 1,277 $ -- $ 99,276
Pledged CMO Collateral 3,215,231 1,620 18,183 3,198,668
------------ ------------ ------------ ------------
$ 3,313,230 $ 2,897 $ 18,183 $ 3,297,944
============ ============ ============ ============
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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 dispositions of debt securities (in
thousands):
QUARTER ENDED MARCH 31
-------------------------
2000 1999
---------- ----------
Sale of securities held available-for-sale:
Amortized cost $ -- $ 7,573
Gains -- 1,761
NOTE 9 -- COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is net income (loss) plus other comprehensive income
(loss), which, for the periods presented, consists of the change in unrealized
gain (loss) on debt securities classified as available-for-sale. The following
table provides information regarding comprehensive income (loss) for the periods
indicated (in thousands):
QUARTER ENDED MARCH 31
--------------------------
2000 1999
---------- ----------
Net income $ 11,670 $ 13,907
Other comprehensive income (loss):
Unrealized gain (loss) on debt securities:
Change in unrealized gain (loss) during period (11,709) 12,546
Reclassification adjustment for gain included in net income -- (1,761)
---------- ----------
Other comprehensive income (loss) (11,709) 10,785
---------- ----------
Comprehensive income (loss) $ (39) $ 24,692
========== ==========
NOTE 10 -- 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
----------------------------------------------------------------
2000 1999
----------------------------- -----------------------------
AMOUNT AVERAGE AMOUNT AVERAGE
------------ ------------ ------------ ------------
Interest income:
Mortgage securities and other investments $ 84,900 6.20% $ 47,312 5.78%
CMO collateral and investments 57,929 7.07 77,030 7.20
------------ ------------
Total interest income 142,829 124,342
------------ ------------
Interest expense:
Short-term borrowings 71,908 5.85 33,914 4.95
CMOs 57,903 7.13 77,517 7.31
------------ ------------
Total interest expense 129,811 111,431
------------ ------------
Net interest $ 13,018 $ 12,911
------------ ------------
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The following table summarizes increases (decreases) in interest income and
interest expense due to changes in interest rates versus changes in volume for
the quarter ended March 31, 2000 compared to the same period in 1999 (in
thousands):
RATE* VOLUME* TOTAL
------------ ------------ ------------
Interest income:
Mortgage securities and other investments $ 3,759 $ 33,829 $ 37,588
CMO collateral and investments (1,327) (17,774) (19,101)
------------ ------------ ------------
Total interest income 2,432 16,055 18,487
------------ ------------ ------------
Interest expense:
Short-term borrowings 7,014 30,980 37,994
CMOs (1,877) (17,737) (19,614)
------------ ------------ ------------
Total interest expense 5,137 13,243 18,380
------------ ------------ ------------
Net interest $ (2,705) $ 2,812 $ 107
============ ============ ============
* The change in interest due to both volume and rate has been allocated
to volume and rate changes in proportion to the relationship of the
absolute dollar amounts of the change in each.
NOTE 11 -- COMMITMENTS AND CONTINGENCIES
Stockholder Litigation. During 1998 twenty-four purported class action lawsuits
were filed against the Company and certain of its officers alleging, among other
things, that the defendants violated federal securities laws by publicly issuing
false and misleading statements and omitting disclosure of material adverse
information regarding the Company's business during various periods between
January 28, 1997 and July 24, 1998. The complaints claim that as a result of
such alleged improper actions, the market price of the Company's equity
securities were artificially inflated during that time period. The complaints
seek monetary damages in an undetermined amount. In March 1999 these actions
were consolidated. The date by which the Company is to respond has not yet run.
The Company believes it has meritorious defenses to the claims and intends to
vigorously defend the actions. Based on available information, management
believes the resolution of these suits will not have a material adverse effect
on the financial position of the Company.
Severance Costs. At the Annual Meeting of the Board of Directors in April, a new
Chairman of the Board of Directors and Chief Executive Officer ("CEO") was
appointed, and Ronn K. Lytle, the Company's former chairman and CEO, terminated
his employment with the Company. Non-recurring severance charges of
approximately $3.4 million related to the settlement of obligations to Mr. Lytle
under the terms of a 1992 Employment Agreement and $225,000 related to the
termination of several other employees of the Company will be charged to expense
in the second quarter of 2000.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
Capstead Mortgage Corporation ("Capstead" or the "Company"), a mortgage
investment firm, earns income from investing in mortgage assets on a leveraged
basis and from other investment strategies.
ELECTION OF NEW LEADERSHIP
At the Company's Annual Meeting of Stockholders held April 20, 2000,
stockholders elected a new Board of Directors including Wesley R. Edens,
chairman of the board of Fortress Investment Group LLC ("Fortress"). An
affiliate of Fortress acquired the Company's Series C and D preferred shares in
December 1999. The composition of the new Board of Directors now includes four
members designated by Fortress and three members designated by Capstead, two of
whom are continuing directors from the previous Board. In addition, the Board
announced the appointment of Mr. Edens to the positions of Chairman of the Board
and Chief Executive Officer of the Company and Ronn K. Lytle, the Company's
previous chairman and chief executive, to the position of Vice Chairman of the
Board.
Non-recurring severance charges of approximately $3.4 million related to the
settlement of obligations to Mr. Lytle under the terms of a 1992 employment
agreement and $225,000 related to the termination of several other employees of
the Company will be charged to expense in the second quarter of 2000.
ADOPTION OF NEW INVESTMENT STRATEGY
During 1999 the Company's primary focus consisted of managing a portfolio of
single-family residential mortgage-backed securities issued by
government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae
("Agency Securities"). On April 20, 2000 the Board approved modifying the
Company's investment strategy to focus on short maturity and adjustable-rate
assets, including but not limited to, credit-sensitive commercial and
residential mortgage-backed securities and ARM Agency Securities. In connection
with this modification, the Company intends to dispose of approximately $1.0
billion of its fixed-rate mortgage investments and approximately $1.1 billion of
its medium-term and ARM securities. As a result, the Company anticipates
recognizing a second quarter loss on the sale of these securities of $85 million
to $90 million, all of which is already reflected in book value per share at
March 31, 2000. Most of these sales are expected to be completed by year-end.
Pending final sale, these securities will be classified as trading securities
and further changes in market value, if any, will be reflected in operating
results. Capital made available because of these sales is expected to be
redeployed over the next several quarters into suitable investments in keeping
with the new investment strategy.
The Company is modifying its investment strategy at this time because of the
risk that interest rates will continue to rise over the next 12 months as the
Federal Reserve continues to fight the prospects of inflation by increasing
short-term interest rates. By focusing the Company's investments on assets that
adjust to a more current interest rate within 1- to 12-months, the Company's new
investment strategy is intended to help preserve capital over the long term and
improve earnings prospects once interest rates stabilize. In addition,
investments in credit-sensitive CMBS may improve earnings stability during
periods of increased interest rate volatility. It may take several quarters to
completely transition to the new investment strategy and its benefits may not be
fully evident until sometime in 2001.
With or without this new investment strategy, the remainder of the year will
likely be very difficult for Capstead from a net income and dividend perspective
should the Federal Reserve continue to increase
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interest rates. Although the overall yield on mortgage assets is currently
anticipated to increase in future quarters with the acquisition of higher
yielding assets in connection with the new investment strategy and the reset of
interest rates on ARM securities to levels more reflective of the current
interest rate environment, borrowing rates are also expected to increase, which
may further reduce net interest margins. Depending on the timing and extent of
any future increases in interest rates over the next several quarters, it may be
necessary to again reduce the dividend on the Company's common stock.
1-FOR-2 REVERSE COMMON STOCK SPLIT
At the Company's Annual Meeting, stockholders approved a 1-for-2 reverse split
of the common stock. Accordingly, the Board of Directors has established the
close of business on May 8, 2000 as the effective date for the reverse split.
The first day the common shares will trade post-split will be May 9, 2000. The
reverse split will reduce the number of outstanding common shares to
approximately 22.5 million. Concurrent with the reverse split, the conversion
ratio for each series of preferred shares, will be adjusted accordingly (see
"NOTE 2" to the accompanying consolidated financial statements).
The accompanying consolidated financial statements and related notes and per
share data included elsewhere in this document have not been adjusted to reflect
the reverse common stock split.
FIRST QUARTER COMMON DIVIDEND
On April 20, 2000 the Board of Directors declared a first quarter dividend of 11
cents per common share, payable May 19 to stockholders of record as of May 5,
2000.
MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities and other investments consist primarily of high quality
single-family residential mortgage-backed securities, most of which are Agency
Securities. Agency Securities have no foreclosure risk; however, the Company is
subject to reduced net interest margins during periods of rising short-term
interest rates or increasing prepayment rates (see "Effects of Interest Rate
Changes"). Non-agency securities consist of private mortgage pass-through
securities whereby the related credit risk of the underlying loans is borne by
AAA-rated private mortgage insurers and other AAA-rated private mortgage
securities (together, "Non-agency Securities"). Although investment grade when
acquired, CMBS held by the Company at March 31, 2000 carry credit risk
associated with the underlying commercial mortgage loans. Features of the
related CMBS issuances, including subordinated securities held by other
investors, helps mitigate this risk (see "Risks Associated With Credit-Sensitive
Investments"). The Company classifies its mortgage securities and other
investments by interest rate characteristics of the underlying loans or the
securities themselves (see "NOTE 5" to the accompanying consolidated financial
statements). Mortgage securities and other investments are financed under
repurchase arrangements with investment banking firms pursuant to which the
portfolios are pledged as collateral (see "Liquidity and Capital Resources").
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The following yield and cost analysis illustrates results achieved during the
most recent quarter for each component of the Company's mortgage investment
portfolio:
AVERAGE FOR THE QUARTER ENDED
MARCH 31, 2000 AS OF MARCH 31, 2000
--------------------------------------------------- --------------------------------
ACTUAL ACTUAL PURCHASE
ANNUALIZED ANNUALIZED PREMIUM
BASIS YIELD/COST RUNOFF (DISCOUNT) BASIS
------------- ------------- ------------- ------------- -------------
* *
Agency securities:
FNMA/FHLMC:
Fixed-rate $ 1,053,524 6.21% 6% $ (2,811) $ 1,043,808
Medium-term 1,107,432 5.94 12 3,930 1,077,590
ARMs:
LIBOR/CMT 915,781 6.38 18 19,681 921,628
COFI 240,484 5.76 13 1,502 235,867
GNMA ARMs 1,925,291 6.06 15 24,437 1,903,102
------------- ------------- ------------- ------------- -------------
5,242,512 6.11 13 46,739 5,181,995
Non-agency Securities 162,545 7.92 20 362 187,880
CMBS - adjustable-rate 68,214 8.59 7 (986) 75,189
------------- ------------- ------------- ------------- -------------
5,473,271 6.20 13% $ 46,115 5,445,064
============= ============= =============
Less:
Mark to market 105,212 -- 103,808
Borrowings 4,865,539 5.85 4,855,340
------------- ------------- -------------
Capital employed/financing spread $ 502,520 0.35% $ 485,916
============= ============= =============
Return on assets 0.94%
* Basis is the Company's investment before mark to market for securities
classified as available-for-sale.
During the first quarter of 2000 the Company acquired approximately $50 million
of Agency Securities and called for the redemption of three series of
off-balance sheet collateralized mortgage obligations ("CMOs") previously issued
by the Company adding $70 million to the Non-agency Securities portfolio.
Consistent with the Company's new investment strategy, in December 1999 the
Company acquired $59 million of adjustable-rate CMBS from a third party not
affiliated with Fortress. An additional $17 million investment in CMBS was made
in the first quarter. Runoff on mortgage investments totaled approximately $192
million. The Company's leverage ratio increased to 7.4:1 at March 31, 2000 from
6.9:1 at December 31, 1999 primarily as a result of the completion of the tender
offer in January 2000.
The unamortized net premium paid for these portfolios (referred to as "purchase
premiums (discounts)") was $46.1 million at March 31, 2000, representing 0.85
percent of related unpaid principal balances. Purchase premiums (discounts) are
amortized to income as yield adjustments based on both actual prepayments and
lifetime prepayment assumptions. Actual prepayments declined further during the
first quarter because of continued high mortgage interest rates which have had a
favorable impact on yields (see "Effects of Interest Rate Changes"). Prepayments
on Fannie Mae and Freddie Mac medium-term and adjustable-rate Agency Securities
declined to an annualized rate of 12.9 percent in March 2000 from 15.5 percent
in December 1999. Prepayments on Ginnie Mae ARMs declined to an annualized rate
of 14.0 percent in March 2000, from 16.9 percent in December 1999.
The average yield on the Company's mortgage investments for the first quarter
was 6.20 percent while the average borrowing rate was 5.85 percent, resulting in
a financing spread of 0.35 percent. Yields on the Company's ARM securities are
currently expected to improve in future quarters as interest rates on
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the underlying mortgage loans reset to levels more reflective of the current
interest rate environment. For example, if interest rates stabilize at April
2000 levels, yields on the ARM securities expected to be retained under the
Company's new investment strategy could improve as much as 82 basis points over
the next 12 months. Conversely, if interest rates decline from current levels,
such a yield improvement will likely not be achieved. The Company currently
anticipates average yields on these ARM securities to improve approximately 15
basis points during the second quarter of 2000. However, taking into
consideration the full impact of increases in short-term interest rates during
the first quarter, and assuming an additional 25 basis point increase in
short-term interest rates by the Federal Reserve at its next Open Market
Committee meeting on May 16, 2000, the Company currently expects its borrowing
rates to average approximately 36 basis points higher during the second quarter.
Actual borrowing rates will be largely dependent upon future actions by the
Federal Reserve to change short-term interest rates. Overall mortgage investment
yields in future quarters will also be impacted by the Company's transition to
its new investment strategy (see "Effects of Interest Rate Changes").
CMO COLLATERAL AND INVESTMENTS
The Company had been an active issuer of CMOs and other securities backed by
single-family residential mortgage loans obtained through a mortgage loan
conduit business that the Company exited in 1995. Since then, the Company has
maintained 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 potentially add to its CMO
administration activities, the Company from time to time purchases mortgage
loans from originators or conduits and issues CMOs or other securities backed by
these loans. The Company may or may not retain a significant residual economic
interest in these securitizations. During the first quarter of 2000, the Company
issued one such CMO totaling $232 million. The Company did not retain any
significant residual economic interest in this issuance.
To date, the related credit risk of the mortgage loans collateralizing CMOs
issued by the Company is borne by AAA-rated private mortgage insurers or by
subordinated bonds within the related CMO series to which the collateral is
pledged. The Company has retained $1.0 million of credit risk in the form of
subordinated bonds associated with approximately $566 million of these
securities remaining outstanding as of March 31, 2000. The Company also retained
residual interests in certain of these securitizations primarily with the
characteristics of interest-only mortgage securities. Interest-only mortgage
securities are entitled to receive all or some portion of the interest stripped
from the mortgage loans underlying the securities. In addition, the Company has
retained $3.2 million of reserve funds in connection with two 1993 mortgage loan
sales. These reserve funds are available to pay special hazard costs (e.g.
earthquake or mudslide-related losses) or certain bankruptcy costs associated
with approximately $141 million of loans remaining outstanding as of March 31,
2000 from the related securitizations.
As of March 31, 2000, the Company's CMO investments (defined as CMO collateral
and investments, net of related bonds) had been reduced to $27.6 million, down
from $29.3 million at December 31, 1999. Included in this net investment are
$12.0 million and $8.5 million of the remaining CMO collateral premiums and bond
discounts, respectively. Similar to purchase premiums on the Company's mortgage
investments, CMO collateral premiums and bond discounts, along with most of
remaining CMO investments, are amortized to income as CMO collateral yield or
bond expense adjustments based on both actual prepayments and lifetime
prepayment assumptions (see "Effects of Interest Rate Changes").
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19
UTILIZATION OF CAPITAL AND POTENTIAL LIQUIDITY
The following table summarizes the Company's utilization of capital and
potential liquidity as of March 31, 2000 (in thousands):
CAPITAL
ASSETS BORROWINGS EMPLOYED LIQUIDITY
--------- ---------- --------- ----------
*
Agency securities:
FNMA/FHLMC:
Fixed-rate $ 984,168 $ 964,533 $ 19,635 $ (4,803)
Medium-term 1,048,598 981,698 66,900 35,442
ARMs:
LIBOR/CMT 926,087 804,690 121,397 93,614
COFI 228,214 156,461 71,753 64,905
GNMA ARMs 1,887,680 1,770,528 117,152 60,522
Non-agency Securities 189,489 115,035 74,454 66,235
CMBS - adjustable-rate 75,699 62,395 13,304 126
CMO collateral and investments 3,455,238 3,427,653 27,585 --
---------- ---------- ---------- ----------
$8,795,173 $8,282,993 512,180 316,041
========== ==========
Other assets, net of other liabilities 39,994 9,389**
---------- ----------
$ 552,174 $ 325,430
========== ==========
* Based on maximum borrowings available under existing uncommitted
repurchase arrangements considering the fair value of related collateral
as of March 31, 2000 (see "Liquidity and Capital Resources").
** Represents unrestricted cash and cash equivalents.
STOCK REPURCHASES AND BOOK VALUE PER COMMON SHARE
During the first quarter, the Company, through open market purchases, acquired
360,500 common shares at an average price of $3.88 (including transaction costs)
and 245,800 shares of its $1.26 Cumulative Convertible Preferred Stock, Series B
("Series B preferred shares") at an average price of $9.59 (including
transaction costs). On January 25, 2000 the Company purchased 11,137,000 common
shares at a price of $4.64 per share (including transaction costs) pursuant to a
tender offer that closed on January 14, 2000. Since share repurchases began in
December 1998 through April 24, 2000, the Company has repurchased 26.9 percent
of its outstanding common shares and 5.5 percent of its Series B preferred
shares. As of April 24, 2000, the Company had remaining authorization to
repurchase 1.6 million common shares and 1.1 million Series B preferred shares.
At March 31, 2000 the Company's book value per common share was $6.07, compared
to $5.91 per common share at December 31, 1999 (calculated assuming redemption
of Series A and B preferred shares and conversion of the Series C and D
preferred shares). Book value per common share increased primarily because of
the completion of the tender offer and additional share repurchases, partially
offset by a further reduction in the market value of the mortgage investment
portfolio of approximately 21 cents per common share caused by the continued
increase in mortgage interest rates during the first quarter. The market value
of the Company's mortgage securities and other investments will continue to
fluctuate with, among other factors, changes in mortgage interest rates and
market liquidity, and such changes will be reflected in book value per common
share.
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RESULTS OF OPERATIONS
Comparative net operating results (interest income or fee revenue, net of
related interest expense and, in the case of CMO administration, related direct
and indirect operating expense) by source were as follows (in thousands, except
per share amounts):
QUARTER ENDED MARCH 31
---------------------
2000 1999
--------- --------
Agency Securities $ 10,920 $ 11,817
Non-agency Securities 1,390 1,529
CMBS - adjustable-rate 542 --
CMO collateral and investments (237) (1,062)
-------- --------
Net margin on mortgage assets and other investments 12,615 12,284
Other operating revenue (expense):
Gain on sale of mortgage assets and derivative
financial instruments -- 1,738
CMO administration and other 784 1,470
Other operating expense (1,729) (1,585)
-------- --------
Net income $ 11,670 $ 13,907
======== ========
Net income per common share:
Basic $ 0.11 $ 0.14
Diluted 0.11 0.14
The earning capacity of the Company's mortgage asset portfolios is largely
dependent on the overall size and composition of the portfolios, the
relationship between short- and long-term interest rates (the "yield curve") and
the extent the Company continues to invest its liquidity in these portfolios. As
discussed above, the Company is modifying its investment strategy to replace a
significant portion of its existing mortgage investments with short maturity and
adjustable-rate assets, including but not limited to, credit-sensitive
commercial and residential mortgage-backed securities and ARM Agency Securities
(see "Financial Condition - Adoption of New Investment Strategy").
Operating results for the quarter ended March 31, 2000 reflect higher borrowing
costs incurred financing mortgage securities and other investments primarily
because of continued actions by the Federal Reserve to increase short-term
interest rates an additional 50 basis points during the first quarter of 2000
for a total of 125 basis points since June 1999. Higher borrowing costs were
only partially offset by the benefits of improving yields on ARM securities,
investments in higher-yielding CMBS, slower prepayment speeds and fewer common
and Preferred B shares outstanding. For a discussion of how the current interest
rate environment is expected to impact the second quarter of 2000 see "Financial
Condition - Mortgage Securities and Other Investments."
Agency Securities contributed less to operating results during the first quarter
of 2000 than in the same period in 1999 because of higher borrowing costs,
despite higher average yields, a significantly higher average portfolio
outstanding and having employed more capital to this portfolio during the
current quarter. Average borrowing costs increased 88 basis points to 5.83
percent during the current quarter, more than twice the 40 basis point
improvement in average yields to 6.11 percent. Yields benefited as interest
rates on mortgage loans underlying ARM securities continued to reset to levels
more reflective of the current interest rate environment and prepayments
continued to slow. The average outstanding portfolio of $5.2 billion during the
current quarter was 64 percent higher than during the same period in 1999, while
on average the Company employed $551 million of its capital to this portfolio
during the current quarter compared to $470 million during the same period in
1999. Non-agency Securities contributed less to operating results during the
first quarter of 2000 than in the same period in 1999 primarily because of
higher borrowing costs. The average outstanding portfolio was
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$163 million during the current quarter financed with average borrowings of $119
million, compared to an average outstanding portfolio of $83 million during the
same period in 1999 funded almost entirely with equity. Average yields for this
portfolio (calculated including mortgage insurance costs) were 7.92 percent
during the first quarter compared to 8.05 percent during the same period in
1999.
CMO collateral and investments results benefited from slowing prepayment rates
allowing remaining collateral premiums and bond discounts to be amortized to
earnings over a longer time frame. In addition, prior period results included
the write-off of bond discounts related to the redemption of CMO bonds. Without
growth of this portfolio either through the issuance of CMOs in which the
Company retains residual interests, or the acquisition of other CMO investments,
this portfolio is not expected to provide a positive return on capital employed
in future periods.
During the first quarter of 2000 the Company did not recognize any gains or
losses on sales of mortgage assets. This compares to prior period sales
primarily of remaining purchased interest-only mortgage securities held as CMO
investments.
CMO administration and other revenue was lower in 2000 as a consequence of the
steady runoff of securitizations on which the Company provides CMO
administration services and lower earnings from short-term investments.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds include borrowings under repurchase
arrangements, monthly principal and interest payments on mortgage securities and
other investments, excess cash flows on CMO collateral and investments and
proceeds from sales of mortgage assets (see "Financial Condition - Utilization
of Capital and Liquidity"). The Company currently believes that these funds are
sufficient for the acquisition of mortgage assets, repayments on borrowings, the
payment of cash dividends as required for Capstead's continued qualification as
a Real Estate Investment Trust ("REIT") and common and preferred share
repurchases as described above. It is the Company's policy to remain strongly
capitalized and conservatively leveraged.
Borrowings under repurchase arrangements secured by Agency Securities and
Non-agency Securities generally have maturities of less than 31 days. The
Company has uncommitted repurchase facilities with investment banking firms to
finance these mortgage assets, subject to certain conditions. Interest rates on
borrowings under these facilities are generally 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. Amounts available to be borrowed under these
arrangements are dependent upon the fair value of the securities pledged as
collateral, which fluctuates with changes in interest rates and the securities'
credit quality.
Borrowings under repurchase arrangements secured by recent purchases of
adjustable-rate CMBS more closely match the interest rate adjustment features
and expected life of these investments such that the Company anticipates it can
earn more consistent net interest spreads on these investments and, as a result,
experience less interest rate volatility than experienced with the Company's
existing mortgage investments. Should the Company make significant additional
investments in credit-sensitive mortgage securities, it is anticipated that the
Company will attempt to lessen interest rate volatility in a similar fashion or
through the use of derivative financial instruments ("Derivatives") such as
interest rate swaps (see "Effects of Interest Rate Changes" and "Risks
Associated with Credit-sensitive Investments").
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EFFECTS OF INTEREST RATE CHANGES
INTEREST RATE SENSITIVITY ON OPERATING RESULTS
The Company performs earnings sensitivity analysis using an income simulation
model to estimate the effects that specific interest rate changes will have on
future earnings. All mortgage assets and Derivatives held, if any, are included
in this analysis. In addition, the sensitivity of CMO administration fee income
to market interest rate levels is included as well. However, given that in April
the Company adopted a new investment strategy focusing on short maturity and
adjustable-rate assets and concluded that it would sell a significant portion of
its longer maturity mortgage assets by year-end, for this presentation the
assets designated for sale are excluded from the March 31, 2000 estimated
earnings sensitivity profile. The model incorporates management assumptions
regarding the level of prepayments on mortgage assets for a given level of
market rate changes using industry estimates of prepayment speeds for various
coupon segments. These assumptions are developed through a combination of
historical analysis and future expected pricing behavior. Primarily because of
the exclusion of longer maturity assets designated for sale as described above,
earnings are less sensitive to changes in interest rates at March 31, 2000 than
at December 31, 1999, as indicated in the following table:
IMMEDIATE CHANGE IN:
(RATES IN BASIS POINTS, DOLLARS IN THOUSANDS)
--------------------------------------------
30-day LIBOR rate Down 100 Down 100 Flat Up 100
10-year U.S. Treasury rate Down 100 Flat Up 100 Up 100
Projected 12-month earnings change:*
As of March 31, 2000 $ 12,358 $ 17,058 $ 4,709 $(19,755)
As of December 31, 1999 31,160 36,190 5,044 (37,821)
* Note that the impact of actual or planned acquisitions of mortgage
assets subsequent to the indicated period-end (beyond acquisitions
necessary to replace runoff) were not factored into the simulation
model for purposes of this disclosure.
Income simulation modeling is a primary tool used to assess the direction and
magnitude of changes in net margins on mortgage assets resulting from changes in
interest rates. Key assumptions in the model include prepayment rates on
mortgage assets, changes in market conditions, and management's financial
capital plans. These assumptions are inherently uncertain and, as a result, the
model cannot precisely estimate net margins or precisely predict the impact of
higher or lower interest rates on net margins. Actual results will differ from
simulated results due to timing, magnitude and frequency of interest rate
changes and other changes in market conditions, management strategies and other
factors.
GENERAL DISCUSSION OF EFFECTS OF INTEREST RATE CHANGES
Changes in interest rates may impact the Company's earnings in various ways. The
Company's earnings currently depend, in part, on the difference between the
interest received on mortgage securities and other investments, and the interest
paid on related short-term borrowings. The resulting spread may be reduced or
even turn negative in a rising short-term interest rate environment. Because a
substantial portion of the Company's mortgage investments are ARM mortgage
securities, the risk of rising short-term interest rates is generally offset to
some extent by increases in the rates of interest earned on the underlying ARM
loans, which reset periodically based on underlying indices (generally 6-month
LIBOR and 1-year U.S. Treasury rates). Since ARM loans generally limit the
amount of such increases 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 loans contributing to lower or
even negative financing spreads. At other times, as seen in 1998, declines in
these indices may be greater than declines in the Company's
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borrowing rates which are generally based on 30-day LIBOR, contributing to lower
or even negative financing spreads. The Company may invest in Derivatives from
time to time as a hedge against rising interest rates on a portion of its
short-term borrowings. At March 31, 2000 the Company did not own any Derivatives
as a hedge against rising interest rates.
Another effect of changes in interest rates is that as long-term interest rates
decrease the rate of principal prepayments on 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. As seen in 1998 prolonged periods of high prepayments can
significantly reduce the expected life of mortgage investments; therefore, 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 short-term interest rates as the
underlying ARM loans reset at lower rates.
Changes in interest rates also impact earnings recognized from CMO investments,
which have consisted primarily of interest-only mortgage securities and
fixed-rate CMO residuals (see "Financial Condition"). The amount of income that
may be generated from interest-only mortgage securities 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 may increase, reducing or even turning negative the
overall return on these investments. As seen in 1998 sustained periods of high
prepayments can result in losses. Conversely, if mortgage interest rates rise,
interest-only mortgage securities tend to perform favorably because underlying
mortgage loans will generally prepay at slower rates, thereby increasing overall
returns. The Company sold its investments in interest-only mortgage securities
in connection with the 1998 restructuring of its mortgage asset portfolios.
CMO residuals behave similarly to interest-only mortgage securities. As seen in
1998 if mortgage interest rates fall, prepayments on the underlying mortgage
loans generally will be higher, thereby reducing or even turning negative the
overall returns on these investments. This is due primarily to the acceleration
of the amortization of bond discounts 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 larger positive interest spread.
The Company periodically sells mortgage assets, which may increase income
volatility because of the recognition of transactional gains or losses. Such
sales may become attractive as values of mortgage assets fluctuate with changes
in interest rates. At other times, such as in 1998, it may become prudent to
significantly downsize the mortgage asset portfolios to mitigate exposure to
further declines in mortgage interest rates or, as is currently being
considered, to shift the Company's investment focus to credit-sensitive mortgage
assets (see "Financial Condition - Proposed Change in Investment Strategy").
RISKS ASSOCIATED WITH CREDIT-SENSITIVE INVESTMENTS
CMBS are generally viewed as exposing an investor to greater risk of loss than
residential mortgage-backed securities since such securities are typically
secured by larger loans to fewer obligors than residential mortgage-backed
securities. Commercial property values and net operating income are subject to
volatility, and net operating income may be sufficient or insufficient to cover
debt service on the related mortgage loan at any given time. The repayment of
loans secured by income-producing properties is typically dependent upon the
successful operation of the related real estate project and the ability of the
applicable property to produce net operating income rather than upon the
liquidation value of the
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underlying real estate. Even when the current net operating income is sufficient
to cover debt service, there can be no assurance that this will continue to be
the case in the future.
Additionally, commercial properties may not readily be convertible to
alternative uses if such properties were to become unprofitable due to
competition, age of improvements, decreased demand, regulatory changes or other
factors. The conversion of commercial properties to alternate uses generally
requires substantial capital expenditures, which may or may not be available.
The availability of credit for commercial mortgage loans will be significantly
dependent upon economic conditions in the markets where such properties are
located, as well as the willingness and ability of lenders to make such loans.
The availability of funds in the credit markets fluctuates and there can be no
assurance that the availability of such funds will increase above, or will not
contract below current levels. In addition, the availability of similar
commercial properties, and the competition for available credit, may affect the
ability of potential purchasers to obtain financing for the acquisition of
properties. This could effect the repayment of commercial mortgages pledged to
secure CMBS.
Credit-sensitive residential mortgage-backed securities differ from CMBS in
several important ways, yet can still carry substantial credit risk. Residential
mortgage securities typically are secured by smaller loans to more obligors than
CMBS, thus spreading the risk of mortgagor default. However, most of the
mortgages supporting these securities are made to homeowners that do not qualify
for Agency loan programs for reasons including loan size, financial condition,
or work or credit history that may be indicative of higher risk of default than
loans qualifying for such programs. As with CMBS, in instances of default the
Company may incur losses if the proceeds from the sale of the underlying
collateral less related foreclosure costs, are less than the unpaid principal
balance of the mortgage loan. However, with residential mortgage-backed
securities, this risk may be mitigated by various forms of credit enhancements
including, but not limited to, primary mortgage insurance.
Through the process of securitizing both commercial and residential mortgages,
credit risk can be heightened or minimized. Senior classes in multi-class
securitizations generally have first priority over cash flows from a pool of
mortgages and, as a result, carry the least risk, highest investment ratings and
the lowest yields. Typically a securitization will also have mezzanine classes
and subordinated classes. Mezzanine classes will generally have somewhat lower
credit ratings and may have average lives that are longer than the senior
classes. Subordinate classes are junior in the right to receive cash flow from
the underlying mortgages, thus providing credit enhancement to the senior and
mezzanine classes. As a result, subordinated securities will have lower credit
ratings because of the elevated risk of credit loss inherent in these
securities.
The availability of capital from external sources to finance investments in
credit-sensitive CMBS and residential mortgage-backed securities that are not
financed to maturity at acquisition may be diminished during periods of mortgage
finance market illiquidity, such as was experienced in 1998. Additionally, if
market conditions deteriorate resulting in substantial declines in value of
these securities, sufficient capital may not be available to support the
continued ownership of such investments, requiring these securities to be sold
at a loss.
There can be no assurance as to what extent, if any, beyond the initial
purchases of CMBS described previously, this proposed strategy to invest in CMBS
or other credit-sensitive securities will be implemented and, if implemented,
whether or not it will be successful in meeting the Company's goals. In
addition, there can be no assurance that the Company will be able to
successfully assess and monitor these risks.
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OTHER
FORWARD LOOKING STATEMENTS
This document contains "forward-looking statements" (within the meaning of the
Private Securities Litigation Reform Act of 1995) that inherently involve risks
and uncertainties. The Company's actual results and liquidity can differ
materially from those anticipated in these forward-looking statements because of
changes in the level and composition of the Company's investments and unforeseen
factors. These factors may include, but are not limited to, changes in general
economic conditions, the availability of suitable investments, fluctuations in
and market expectations for fluctuations in interest rates and levels of
mortgage prepayments, deterioration in credit quality and ratings, the
effectiveness of risk management strategies, the impact of leverage, liquidity
of secondary markets and credit markets, increases in costs and other general
competitive factors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS
The information required by this Item is incorporated by reference to the
information included in Item 2. "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
PART II. -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
The following Exhibits are presented herewith:
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: None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CAPSTEAD MORTGAGE CORPORATION
Date: May 5, 2000 By: /s/ ANDREW F. JACOBS
------------------------------
Andrew F. Jacobs
Executive Vice President - Finance
Date: May 5, 2000 By: /s/ PHILLIP A. REINSCH
------------------------------
Phillip A. Reinsch
Senior Vice President - Control
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
12 Computation of Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividends
27 Financial Data Schedule (electronic filing only)