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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, 2001
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 NORTH 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) 27,508,880 as of May 7, 2001
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CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2001
INDEX
PAGE
----
PART I. -- FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Balance Sheets -- March 31, 2001 and December 31, 2000 .............. 3
Consolidated Statements of Operations -- Quarter Ended March 31, 2001 and 2000 ... 4
Consolidated Statements of Cash Flows -- Quarter Ended March 31, 2001 and 2000 ... 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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ITEM 1. FINANCIAL STATEMENTS
PART I. -- FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
MARCH 31, 2001 DECEMBER 31, 2000
-------------- -----------------
(UNAUDITED)
ASSETS
Mortgage investments
($4.3 billion pledged under repurchase arrangements) $ 4,682,937 $ 5,394,459
CMO collateral and investments 3,020,161 3,126,878
----------- -----------
7,703,098 8,521,337
Prepaids, receivables and other 70,599 67,399
Cash and cash equivalents 13,373 21,761
----------- -----------
$ 7,787,070 $ 8,610,497
=========== ===========
LIABILITIES
Borrowings under repurchase arrangements $ 4,168,018 $ 4,904,632
Collateralized mortgage obligations ("CMOs") 2,998,224 3,103,874
Accounts payable and accrued expenses 17,604 31,112
----------- -----------
7,183,846 8,039,618
----------- -----------
PREFERRED STOCK SUBJECT TO REPURCHASE
$0.56 Cumulative Convertible Preferred Stock, Series C,
$0.10 par value; 5,378 shares authorized, issued and
outstanding March 31, 2001 and December 31, 2000,
respectively (converted into common shares May 4, 2001) 25,210 25,210
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value; 94,622 shares authorized:
$1.60 Cumulative Preferred Stock, Series A,
374 shares issued and outstanding at
both March 31, 2001 and December 31, 2000
($6,134 aggregate liquidation preference) 5,228 5,228
$1.26 Cumulative Convertible Preferred Stock, Series B,
15,845 shares issued and outstanding at
both March 31, 2001 and December 31, 2000
($180,316 aggregate liquidation preference) 177,012 177,012
Common stock - $0.01 par value; 100,000 shares authorized;
24,725 and 25,282 shares issued and outstanding at
March 31, 2001 and December 31, 2000, respectively 247 253
Paid-in capital 733,340 740,613
Accumulated deficit (378,127) (396,882)
Accumulated other comprehensive income 40,314 19,445
----------- -----------
578,014 545,669
----------- -----------
$ 7,787,070 $ 8,610,497
=========== ===========
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
QUARTER ENDED MARCH 31
----------------------
2001 2000
--------- ---------
INTEREST INCOME:
Mortgage investments $ 87,542 $ 84,900
CMO collateral and investments 55,785 57,929
--------- ---------
Total interest income 143,327 142,829
--------- ---------
INTEREST AND RELATED EXPENSE:
Borrowings under repurchase arrangements 65,162 71,908
CMO borrowings 55,615 57,903
Mortgage insurance and other 328 403
--------- ---------
Total interest and related expense 121,105 130,214
--------- ---------
Net margin on mortgage assets 22,222 12,615
--------- ---------
OTHER REVENUE (EXPENSE):
Gain on sale of mortgage assets 5,863 --
CMO administration and other 719 784
Other operating expense (4,155) (1,729)
--------- ---------
Total other operating revenue (expense) 2,427 (945)
--------- ---------
NET INCOME $ 24,649 $ 11,670
========= =========
Net income $ 24,649 $ 11,670
Less cash dividends paid on preferred stock (5,894) (6,271)
--------- ---------
Net income available to common stockholders $ 18,755 $ 5,399
========= =========
NET INCOME PER COMMON SHARE:
Basic $ 0.75 $ 0.22
Diluted 0.69 0.22
CASH DIVIDENDS DECLARED PER SHARE:
Common $ 0.490 $ 0.240
Series A Preferred 0.400 0.400
Series B Preferred 0.315 0.315
Series C Preferred (converted into common shares May 4, 2001) -- 0.140
Series D Preferred (converted into common shares December 28, 2000) -- 0.100
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
QUARTER ENDED MARCH 31
----------------------
2001 2000
--------- ---------
OPERATING ACTIVITIES:
Net income $ 24,649 $ 11,670
Noncash items:
Amortization of discount and premium 6,990 5,295
Depreciation and other amortization 268 205
Gain on sale of mortgage assets (5,863) --
Net change in prepaids, receivables, other assets, accounts payable
and accrued expenses (15,303) (10,307)
--------- ---------
Net cash provided by operating activities 10,741 6,863
--------- ---------
INVESTING ACTIVITIES:
Purchases of mortgage securities and other investments (87,322) (137,376)
Purchases of CMO collateral and investments -- (232,358)
Principal collections on mortgage investments 363,076 191,758
Proceeds from sales of mortgage assets 457,182 --
CMO collateral:
Principal collections 105,238 95,168
Decrease in accrued interest receivable 663 576
Decrease (increase) in short-term investments (434) 254
--------- ---------
Net cash provided by (used in) investing activities 838,403 (81,978)
--------- ---------
FINANCING ACTIVITIES:
Decrease in borrowings under repurchase arrangements (736,614) (17,052)
CMO borrowings:
Issuance of securities -- 232,358
Principal payments on securities (107,113) (96,604)
Decrease in accrued interest payable (601) (509)
Capital stock transactions (7,310) (55,516)
Dividends paid (5,894) (6,661)
--------- ---------
Net cash provided by (used in) financing activities (857,532) 56,016
--------- ---------
Net change in cash and cash equivalents (8,388) (19,099)
Cash and cash equivalents at beginning of period 21,761 28,488
--------- ---------
Cash and cash equivalents at end of period $ 13,373 $ 9,389
========= =========
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
NOTE 1 -- BUSINESS
Capstead Mortgage Corporation, a mortgage investment firm operating as a real
estate investment trust ("REIT"), earns income from investing in mortgage assets
on a leveraged basis and from other investment strategies. Currently, the
Company's investment strategy focuses on real estate-related assets, including,
but not limited to, adjustable-rate single-family residential mortgage-backed
securities issued by government-sponsored entities, either Fannie Mae, Freddie
Mac or Ginnie Mae ("Agency Securities") and credit-sensitive commercial and
residential real estate-related assets. Fannie Mae, Freddie Mac and Ginnie Mae
are also referred to as FNMA, FHLMC and GNMA, respectively.
NOTE 2 -- BASIS OF PRESENTATION
Basis of Presentation of Interim Financial Information. 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, 2001 are not necessarily
indicative of the results that may be expected for the calendar year ending
December 31, 2001. 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, 2000.
Adoption of New Derivative Financial Instrument Accounting Rules. Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133") establishes new accounting and reporting
standards for derivative financial instruments ("Derivatives") and hedging
activities. It requires recognition of all Derivatives, including certain
Derivatives not previously afforded accounting recognition, as either assets or
liabilities on the balance sheets and measurement of those instruments at fair
value. If certain conditions are met, a Derivative may be specifically
designated as (i) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (ii) a hedge
of the exposure to variable cash flows of a forecasted transaction or existing
asset or liability, or (iii) in certain circumstances, a hedge of a foreign
currency exposure. The Company adopted SFAS 133 January 1, 2001 and recognized
in Other comprehensive income certain clean-up call rights on off-balance sheet
securitizations as cash flow hedge instruments (see NOTE 11). These call rights
allow the Company to lock in a maximum price for a modest amount of
adjustable-rate mortgage-backed securities that the Company expects to purchase
in the future, provided certain requirements specified in the related indentures
have been met.
NOTE 3 -- TENDER OFFER AND FIRST QUARTER COMMON DIVIDEND
Tender Offer. On March 22, 2001 the Company purchased 551,690 common shares at a
price of $13.25 per share (including transaction costs) pursuant to a tender
offer that closed on March 16, 2001.
First Quarter Dividend. On April 19, 2001 the Board of Directors declared a
first quarter dividend of $0.49 per common share, payable May 21, 2001 to
stockholders of record as of May 7, 2001.
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NOTE 4 -- CAPITAL TRANSACTIONS SUBSEQUENT TO QUARTER END
Special Dividend. On April 30, 2001 the Board of Directors declared a special
dividend of $7.30 per common share, or approximately $200 million of the
Company's Paid-in capital, payable June 29, 2001 to stockholders of record as of
June 13, 2001. Because of the significance of this distribution, the common
shares will not trade ex-dividend until July 2, 2001. Common stockholders who
sell their shares after the record date, and through the payment date, will also
be selling their right to receive the special dividend.
1-For-2 Reverse Common Stock Split. In conjunction with declaring the special
common dividend on April 30, 2001, the Company also announced it has called a
special meeting of stockholders to be held June 15, 2001 for the purpose of
approving a 1-for-2 reverse stock split of its common stock. A detailed
description of this proposal will be provided in a proxy statement expected to
be distributed to stockholders on or about May 17, 2001. The record date for
determining stockholders entitled to notice of and to vote at the special
meeting will be the close of business on May 11, 2001. The Board anticipates
establishing the close of business on June 29, 2001, as the effective date of
the reverse split. As such, the first day the common shares will trade
post-split will be July 2, 2001. This coincides with the first day that the
common shares will begin trading ex-special dividend. The consolidated financial
statements and related notes have not been adjusted to reflect the reverse
common stock split.
Conversion of Series C Preferred Shares. On May 4, 2001 Fortress Investment
Group LLC ("Fortress") converted the Series C preferred shares it acquired
through an affiliate in December 1999, into 2,689,000 common shares. Fortress
controls 34% of the voting shares of the Company. Wesley R. Edens, the Company's
Chairman of the Board and Chief Executive Officer, is also chairman of the board
of Fortress.
NOTE 5 -- NET INCOME PER COMMON SHARE
Basic net income per common share is computed by dividing net income after
deducting preferred share dividends, as herein defined, 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
antidilutive convertible preferred shares, by the weighted average number of
common shares, dilutive stock options and dilutive convertible preferred shares
outstanding.
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The components of the computation of basic and diluted net income per share were
as follows (in thousands, except per share data):
QUARTER ENDED MARCH 31
----------------------
2001 2000
--------- ---------
NUMERATOR FOR BASIC NET INCOME PER COMMON SHARE:
Net income $ 24,649 $ 11,670
Less all preferred share dividends* (5,894) (6,271)
-------- --------
Net income available to common stockholders $ 18,755 $ 5,399
======== ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 25,114 24,317
======== ========
BASIC NET INCOME PER COMMON SHARE $ 0.75 $ 0.22
======== ========
NUMERATOR FOR DILUTED NET INCOME PER COMMON SHARE:
Net income $ 24,649 $ 11,670
Less cash dividends paid on antidilutive convertible preferred shares:
Series A -- (150)
Series B (4,991) (5,221)
Series B repurchase amounts less than book value* -- 390
Series C (converted into common shares May 4, 2001) -- (753)
Series D (converted into common shares December 28, 2000) ** --
-------- --------
$ 19,658 $ 5,936
======== ========
DENOMINATOR FOR DILUTED NET INCOME PER COMMON SHARE:
Weighted average common shares outstanding 25,114 24,317
Net effect of dilutive stock options 155 10
Net effect of dilutive preferred shares 3,102 2,689
-------- --------
28,371 27,016
======== ========
DILUTED NET INCOME PER COMMON SHARE $ 0.69 $ 0.22
======== ========
* 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.
NOTE 6 -- MORTGAGE INVESTMENTS
Mortgage investments and the related average interest rates were as follows
(dollars in thousands):
AVERAGE
PRINCIPAL PREMIUMS CARRYING AVERAGE EFFECTIVE
BALANCE (DISCOUNT) BASIS AMOUNT COUPON RATE
----------- ----------- ----------- ----------- ----------- -----------
* ** **
MARCH 31, 2001
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 3,353 $ 16 $ 3,369 $ 3,586 10.00% 9.89%
Medium-term 101,674 226 101,900 103,145 6.36 6.94
LIBOR/CMT ARMs 2,106,777 37,088 2,143,865 2,159,667 8.22 7.08
COFI ARMs 203,353 (4,745) 198,608 205,514 6.85 7.36
GNMA ARMs 2,018,225 18,312 2,036,537 2,048,611 7.15 6.93
----------- ----------- ----------- ----------- ----------- -----------
4,433,382 50,897 4,484,279 4,520,523 7.63 6.67
Non-agency securities 86,505 13 86,518 88,149 8.43 8.23
CMBS - adjustable-rate 74,058 (589) 73,469 74,265 7.09 8.35
----------- ----------- ----------- ----------- ----------- -----------
$ 4,593,945 $ 50,321 $ 4,644,266 $ 4,682,937 7.64% 7.06%
=========== =========== =========== =========== =========== ===========
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AVERAGE
PRINCIPAL PREMIUMS CARRYING AVERAGE EFFECTIVE
BALANCE (DISCOUNT) BASIS AMOUNT COUPON RATE
----------- ----------- ----------- ----------- ----------- -----------
DECEMBER 31, 2000
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 3,411 $ 16 $ 3,427 $ 3,646 10.00% 9.73%
Medium-term 586,954 (5,357) 581,597 585,756 6.19 7.00
LIBOR/CMT ARMs 2,176,060 40,140 2,216,200 2,225,118 8.19 7.11
COFI ARMs 209,721 (4,957) 204,764 208,672 6.78 7.58
GNMA ARMs 2,181,958 18,323 2,200,281 2,199,649 7.07 6.92
----------- ----------- ----------- ----------- ----------- -----------
5,158,104 48,165 5,206,269 5,222,841 7.43 7.03
Non-agency securities 94,538 -- 94,538 96,390 8.44 8.21
CMBS - adjustable-rate 74,920 (688) 74,232 75,228 8.68 9.35
----------- ----------- ----------- ----------- ----------- -----------
$ 5,327,562 $ 47,477 $ 5,375,039 $ 5,394,459 7.47% 7.09%
=========== =========== =========== =========== =========== ===========
* Includes mark-to-market for securities classified as available-for-sale, if
applicable (see NOTE 10).
** Average Coupon is presented as of the indicated balance sheet date. Average
Effective Rate is presented for the quarter then ended, calculated
including mortgage insurance costs on non-agency securities and excluding
unrealized gains and losses.
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 the 1-year Constant Maturity U.S. Treasury Note Rate ("1-year CMT"), 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 CMT, (ii) have initial
interest rates that adjust one time, approximately 3 or 5 years after
origination, 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 annually
based on a specified margin over 1-year CMT, (ii) adjust semiannually based on a
specified margin over the 6-month London Interbank Offered Rate ("LIBOR"), (iii)
adjust monthly based on a specific margin over the Cost of Funds Index ("COFI")
as published by the Eleventh District Federal Reserve Bank, or (iv) were
previously classified as medium-term and have begun adjusting annually based on
a specified margin over 1-year CMT. CMBS held as of December 31, 2000 adjust
monthly based on a specified margin over 30-day LIBOR.
Agency Securities are AAA-rated and 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 currently investment grade, CMBS held by the Company at
March 31, 2001 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 7 -- 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
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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 only $737,000 of
credit risk in the form of subordinated bonds associated with approximately $487
million of these securities outstanding as of March 31, 2001. The weighted
average effective interest rate for total Pledged CMO Collateral was 7.31%
during the quarter ended March 31, 2001.
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 losses (e.g. earthquake or mudslide-related losses) or
certain bankruptcy costs associated with approximately $123 million of loans
remaining outstanding as of March 31, 2001 from the related securitizations. The
components of CMO collateral and investments were as follows (in thousands):
MARCH 31, 2001 DECEMBER 31, 2000
-------------- -----------------
Pledged CMO Collateral:
Pledged mortgage securities $2,982,631 $3,088,579
Short-term investments 925 491
Accrued interest receivable 18,012 18,675
---------- ----------
3,001,568 3,107,745
Unamortized premium 15,844 16,322
---------- ----------
3,017,412 3,124,067
CMO investments 2,749 2,811
---------- ----------
$3,020,161 $3,126,878
========== ==========
NOTE 8 -- BORROWINGS UNDER REPURCHASE ARRANGEMENTS
Borrowings made under uncommitted repurchase arrangements with investment
banking firms pursuant to which the Company pledges mortgage securities as
collateral generally have maturities of less than 31 days. Repurchase
arrangements with CMBS pledged as collateral generally have longer maturities.
The terms and conditions of these arrangements are negotiated on a
transaction-by-transaction basis. Repurchase arrangements and related weighted
average interest rates, classified by type of collateral and maturities, were as
follows (dollars in thousands):
MARCH 31, 2001 DECEMBER 31, 2000
---------------------- ----------------------
BORROWINGS AVERAGE BORROWINGS AVERAGE
OUTSTANDING RATE OUTSTANDING RATE
----------- ------- ----------- -------
Agency Securities (less than 31 days) $4,106,625 5.07% $4,616,784 6.58%
Agency Securities (31 to 90 days) -- -- 218,104 6.55
Non-agency Securities (less than 31 days) -- -- 6,947 6.90
CMBS (less than 1 year) 47,741 5.66 49,145 7.25
CMBS (over 1 year) 13,652 5.73 13,652 7.25
---------- ------- ---------- -------
$4,168,018 5.08% $4,904,632 6.59%
========== ======= ========== =======
The weighted average effective interest rate on borrowings under repurchase
arrangements was 5.81% during the quarter ended March 31, 2001.
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NOTE 9 -- CMO BORROWINGS
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, 2001 DECEMBER 31, 2000
-------------- -----------------
CMOs $ 2,981,203 $ 3,087,167
Accrued interest payable 17,167 17,768
----------- -----------
Total obligation 2,998,370 3,104,935
Unamortized discount (146) (1,061)
----------- -----------
$ 2,998,224 $ 3,103,874
=========== ===========
Range of average interest rates 4.89% to 9.43% 4.95% to 9.45%
Range of stated maturities 2008 to 2030 2008 to 2030
Number of series 25 26
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 7.33% during the quarter ended March 31, 2001.
NOTE 10 -- 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
COST UNREALIZED UNREALIZED FAIR
BASIS GAINS LOSSES VALUE
---------- ---------- ---------- ----------
AS OF MARCH 31, 2001
Agency Securities:
Fixed-rate $ 3,369 $ 217 $ -- $ 3,586
Medium-term 101,900 1,245 -- 103,145
ARMs 4,379,010 37,246 2,464 4,413,792
---------- ---------- ---------- ----------
4,484,279 38,708 2,464 4,520,523
Non-agency Securities 85,327 1,631 -- 86,958
CMBS - adjustable-rate 73,469 796 -- 74,265
CMO collateral and investments 70,799 760 97 71,462
---------- ---------- ---------- ----------
$4,713,874 $ 41,895 $ 2,561 $4,753,208
========== ========== ========== ==========
AS OF DECEMBER 31, 2000
Agency Securities:
Fixed-rate $ 3,427 $ 219 $ -- $ 3,646
Medium-term 581,597 5,176 1,017 585,756
ARMs 4,621,245 20,165 7,971 4,633,439
---------- ---------- ---------- ----------
5,206,269 25,560 8,988 5,222,841
Non-agency Securities 94,538 1,852 -- 96,390
CMBS - adjustable-rate 74,232 996 -- 75,228
CMO collateral and investments 74,648 196 171 74,673
---------- ---------- ---------- ----------
$5,449,687 $ 28,604 $ 9,159 $5,469,132
========== ========== ========== ==========
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 Non-agency Securities. Fair value disclosures for debt securities
held-to-maturity were as follows (in thousands):
GROSS GROSS
COST UNREALIZED UNREALIZED FAIR
BASIS GAINS LOSSES VALUE
---------- ---------- ---------- ----------
AS OF MARCH 31, 2001
Non-agency Securities $ 1,191 $ 84 $ -- $ 1,275
Pledged CMO Collateral 2,948,699 1,206 13,535 2,936,370
---------- ---------- ---------- ----------
$2,949,890 $ 1,290 $ 13,535 $2,937,645
========== ========== ========== ==========
AS OF DECEMBER 31, 2000
Pledged CMO Collateral $3,052,205 $ 1,204 $ 14,326 $3,039,083
========== ========== ========== ==========
Sales of released CMO collateral occasionally occur provided the collateral has
paid down to within 15% of its original issuance amounts. Dispositions of debt
securities were as follows (in thousands):
QUARTER ENDED MARCH 31
----------------------
2001 2000
-------- --------
Sale of securities held available-for-sale:
Amortized cost $451,319 $ --
Gain 5,863 --
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NOTE 11 -- COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is net income plus other comprehensive income
(loss), which, for the periods presented, consists primarily of the change in
unrealized gain (loss) on debt securities classified as available-for-sale. The
quarter ended March 31, 2001 also includes the effect on other comprehensive
income of adopting SFAS 133. The following table provides information regarding
comprehensive income (loss) (in thousands):
QUARTER ENDED MARCH 31
----------------------
2001 2000
--------- ---------
Net income $ 24,649 $ 11,670
Other comprehensive income (loss):
Unrealized gain on Derivatives held as cash flow hedges:
Initial gain upon adoption of SFAS 133 1,365 --
Change in unrealized gain during period (372) --
Reclassification adjustment for gain included in net income (13)
-------- --------
980 --
Unrealized gain (loss) on debt securities:
Change in unrealized gain (loss) during period 25,752 (11,709)
Reclassification adjustment for gain included in net income (5,863)
-------- --------
Other comprehensive income (loss) 20,869 (11,709)
-------- --------
Comprehensive income (loss) $ 45,518 $ (39)
======== ========
NOTE 12 -- NET INTEREST INCOME ANALYSIS
The following summarizes interest income and interest expense and weighted
average interest rates (dollars in thousands):
QUARTER ENDED MARCH 31
------------------------------------------------
2001 2000
---------------------- ----------------------
AVERAGE AVERAGE
EFFECTIVE EFFECTIVE
AMOUNT RATE AMOUNT RATE
-------- --------- -------- ---------
Interest income:
Mortgage investments $ 87,542 7.06% $ 84,900 6.20%
CMO collateral and investments 55,785 7.30 57,929 7.07
-------- --------
Total interest income 143,327 142,829
-------- --------
Interest expense:
Borrowings under repurchase arrangements 65,162 5.81 71,908 5.85
CMO borrowings 55,615 7.33 57,903 7.13
-------- --------
Total interest expense 120,777 129,811
-------- --------
$ 22,550 $ 13,018
======== ========
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Changes in interest income and interest expense due to changes in interest rates
versus changes in volume were as follows (in thousands):
RATE* VOLUME* TOTAL
-------- -------- --------
Interest income:
Mortgage investments $ 11,167 $ (8,525) $ 2,642
CMO collateral and investments 1,859 (4,003) (2,144)
-------- -------- --------
Total interest income 13,026 (12,528) 498
-------- -------- --------
Interest expense:
Borrowings under repurchase arrangements (435) (6,311) (6,746)
CMO borrowings 1,632 (3,920) (2,288)
-------- -------- --------
Total interest expense 1,197 (10,231) (9,034)
-------- -------- --------
$ 11,829 $ (2,297) $ 9,532
======== ======== ========
* 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 13 -- COMMITMENTS AND CONTINGENCIES
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. In March 1999, these actions were consolidated
and in July 2000, a lead plaintiff group was appointed by the court. An amended
complaint was filed October 20, 2000. The amended complaint claims that as a
result of alleged improper actions, the market prices of the Company's equity
securities were artificially inflated during the period between April 17, 1997
and June 26, 1998. The amended complaint seeks monetary damages in an
undetermined amount. On February 20, 2001 the Company responded to this amended
complaint with a motion to dismiss all allegations against the Company and the
named officers. On April 20, 2001 the plaintiffs responded to the Company's
motion to dismiss. The Company expects to file its reply to the plaintiffs'
response no later than May 21, 2001. 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.
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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 operating as a real estate investment trust ("REIT"), earns
income from investing in mortgage assets on a leveraged basis and from other
investment strategies. Currently, the Company's investment strategy focuses on
real estate-related assets, including, but not limited to, adjustable-rate
single-family residential mortgage-backed securities issued by
government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae
("Agency Securities") and credit-sensitive commercial and residential real
estate-related assets, which, when combined with the prudent use of leverage,
can provide attractive returns. Fannie Mae, Freddie Mac and Ginnie Mae are also
referred to as FNMA, FHLMC and GNMA, respectively.
Actions taken by the Federal Reserve during the first four months of 2001 to
lower short-term interest rates a total of 200 basis points have contributed
significantly to improvements in Capstead's financing spreads (the difference
between yields earned on mortgage investments and rates charged on related
borrowings) and the market value of the Company's mortgage assets. As a result,
earnings have improved (see below, "Mortgage investments" and "Results of
Operations") and book value per common share has increased to $14.09 at March
31, 2001, from $13.11 at December 31, 2000 (calculated excluding the first
quarter 2001 common dividend, and assuming redemption of the Series A and B
preferred shares and conversion of the Series C preferred shares). The market
value of the Company's mortgage assets will continue to fluctuate with changes
in interest rates and market liquidity, and such changes will generally be
reflected in book value per common share. Earnings and book value also benefited
during the quarter from $5.9 million in gains on the previously announced sale
of most of Capstead's remaining medium-term mortgage assets and, to a lesser
extent, the repurchase of 551,690 common shares at a price of $13.25 per share
(including transaction costs) pursuant to a tender offer that closed March 16,
2001.
On April 30, 2001 the Board of Directors declared a special dividend of $7.30
per common share, or approximately $200 million of the Company's Paid-in
capital, payable June 29, 2001 to stockholders of record as of June 13, 2001.
Because of the significance of this distribution, the common shares will not
trade ex-dividend until July 2, 2001. The special dividend is designed to
optimize Capstead's equity capital, creating a capital structure capable of
generating enhanced returns to common equity stockholders, particularly under
current market conditions, while maintaining adequate liquidity. No asset sales
are expected to be necessary to fund the dividend.
In conjunction with declaring the special common dividend, on April 30, 2001 the
Company announced it has called a special meeting of stockholders to be held
June 15, 2001 for the purpose of approving a 1-for-2 reverse stock split of its
common stock. A detailed description of this proposal will be provided in a
proxy statement expected to be distributed to stockholders on or about May 17,
2001. The record date for determining stockholders entitled to notice of and to
vote at the special meeting will be the close of business on May 11, 2001. The
Board anticipates establishing the close of business on June 29, 2001, as the
effective date of the reverse split. As such, the first day the common shares
will trade post-split will be July 2, 2001. This coincides with the first day
that the common shares begin trading ex-special dividend. Share amounts and per
share data have not been adjusted to reflect the reverse common stock split.
On May 4, 2001 Fortress Investment Group LLC ("Fortress") converted the Series C
preferred shares it acquired through an affiliate in December 1999, into
2,689,000 common shares. Fortress controls 34% of
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16
the voting shares of the Company. Wesley R. Edens, the Company's Chairman of the
Board and Chief Executive Officer, is also chairman of the board of Fortress.
MORTGAGE INVESTMENTS
Mortgage investments consist primarily of high quality single-family residential
mortgage-backed securities, most of which are adjustable-rate mortgage ("ARM")
Agency Securities (see NOTE 6 to the accompanying consolidated financial
statements for further discussion of how the Company classifies its mortgage
investments). Agency Securities are AAA-rated and have no foreclosure risk.
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"). The Company also invests in
credit-sensitive commercial mortgage-backed securities ("CMBS"). Although
currently investment grade, these securities 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").
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").
The Company's mortgage investment portfolio declined during the first quarter of
2001 to $4.7 billion from $5.4 billion at year-end 2000 as a result of portfolio
runoff and the previously announced sale of over $400 million of medium-term
securities. Purchases were limited to $87 million of ARM securities. Although up
to this point the Company has made only limited acquisitions of credit-sensitive
mortgage assets such as CMBS, it continues to evaluate suitable investments.
These investments may include commercial and residential real estate-related
assets which, when combined with the prudent use of leverage, can provide
attractive returns. The future size and composition of the Company's mortgage
investment portfolio will depend on market conditions, including levels of
mortgage prepayments and the availability of suitable investments at attractive
pricing (see "Effects of Interest Rate Changes").
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The following yield and cost analysis illustrates results achieved during the
first quarter 2001 for each component of the mortgage investment portfolio and
anticipated second quarter 2001 asset yields and borrowing rates as first
projected by the Company on April 19, 2001 (the date first quarter 2001 results
were released and based on interest rates in effect at that date) (dollars in
thousands):
1ST QUARTER AVERAGE AS OF MARCH 31, 2001
---------------------------------------- --------------------------- PROJECTED LIFETIME
ACTUAL ACTUAL PREMIUMS 2ND QUARTER PREPAYMENT
BASIS YIELD/COST RUNOFF (DISCOUNTS) BASIS YIELD/COST ASSUMPTIONS
----------- ----------- ----------- ----------- ----------- ----------- -----------
* * ** **
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 3,395 9.89% 7% $ 16 $ 3,369 9.60% 25%
Medium-term 227,721 6.94 20 226 101,900 6.11 25
LIBOR/CMT ARMs 2,214,537 7.08 25 37,088 2,143,865 6.80 40
COFI ARMs 202,308 7.36 12 (4,745) 198,608 6.72 15
GNMA ARMs 2,140,864 6.93 28 18,312 2,036,537 6.56 26
----------- ----------- ----------- ----------- ----------- ----------- -----------
4,788,825 7.02 26 50,897 4,484,279 6.67 32
Non-agency Securities 90,531 8.23 33 13 86,518 7.99 30
CMBS - adjustable-rate 73,595 8.35 4 (589) 73,469 7.39 --
----------- ----------- ----------- ----------- ----------- ----------- -----------
4,952,951 7.06 26% $ 50,321 4,644,266 6.71 32%
=========== =========== ===========
Borrowings 4,534,101 5.81 (4,168,018) 4.68
----------- ----------- ----------- -----------
Capital employed/
financing spread $ 418,850 1.25% $ 476,248 2.03%
=========== =========== =========== ===========
* Basis represents the Company's investment before mark-to-market.
** Projected yields for the second quarter 2001 reflect ARM coupon resets and
lifetime prepayment assumptions as adjusted for expected prepayments for
this quarter only as of April 19, 2001 (the date the Company released first
quarter 2001 results and based on interest rates in effect at that date).
Actual yields realized in future periods will largely depend upon (i)
changes in portfolio composition, (ii) ARM coupon resets, (iii) actual
prepayments and (iv) any changes in lifetime prepayment assumptions. Actual
net margin on mortgage assets is also dependent on portfolio size and the
extent the Company continues to deploy its liquidity in these portfolios
(see "Effects of Interest Rate Changes").
The overall yield earned on the mortgage investment portfolio averaged 7.06%
during the first quarter of 2001, compared to 7.09% during the fourth quarter of
2000. As expected, yields on ARM securities peaked during the first quarter of
2001 and then began declining, reflecting the current trend of declining
interest rates that has been evident since the Federal Reserve began lowering
short-term interest rates in January 2001. Yields on ARM securities are expected
to continue to decline in the coming quarters. For example, if interest rates
stabilize at rates in effect April 19, 2001, average quarterly yields on the
Company's current holdings of ARM securities could decline a total of 116 basis
points by the first quarter of next year. Actual yields on ARM securities will
depend on fluctuations in, and market expectations for fluctuations in, interest
rates and levels of mortgage prepayments (see "Effects of Interest Rate
Changes").
The principal prepayment rates on holdings of ARM securities increased during
the first quarter of 2001 and are anticipated to increase further during the
second quarter. Currently, coupon interest rates on most of the mortgage loans
underlying these ARM securities are above prevailing fixed-rate mortgage
interest rates, which is expected to prompt higher levels of prepayments until
such time as these loans reset to lower levels as discussed above. Annualized
prepayment rates on Ginnie Mae ARM securities averaged 28.2% during the first
quarter of 2001, significantly higher than the 18.4% annualized rate during the
fourth quarter of 2000. Annualized prepayment rates on Fannie Mae and Freddie
Mac ARM securities averaged 24.6% during the first quarter of 2001, compared to
23.5% during the prior quarter. While lower prepayment levels improve mortgage
investment yields by allowing related purchase premiums to be recognized in
operating results over a longer period, higher prepayment levels shorten the
period over which the premiums are amortized thus reducing investment yields. As
a result of the increased
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prepayments, net amortization of purchase premiums on holdings of ARM securities
increased to $4.9 million during the first quarter, from $3.1 million during the
fourth quarter of 2000. As of March 31, 2001, the net premium on holdings of ARM
securities was 1.15% of principal, or $50.7 million.
With its most recent action on April 18, 2001, the Federal Reserve has reduced
the Federal Funds Rate by a total of 200 basis points since the beginning of
this year in response to concerns over economic weakness. The 50 basis point
reductions on each of January 3, January 31 and March 20, 2001 contributed to a
76 basis point decline in the Company's average borrowing rates to 5.81% during
the first quarter from 6.57% during the fourth quarter of 2000. The Company's
borrowing rates are expected to decline another 113 basis points in the second
quarter of 2001 as the full effect of the first quarter interest rate reductions
and most of the effect of the April rate reduction are realized. Any further
changes in the Company's borrowing rates will depend on future actions by the
Federal Reserve to change short-term interest rates, market expectations of
future changes in short-term interest rates and the extent of any financial
market liquidity concerns (see "Effects of Interest Rate Changes").
CMO COLLATERAL AND INVESTMENTS
Since exiting the residential mortgage loan conduit business in 1995, Capstead
has maintained finance subsidiaries with capacity to issue CMOs and other
securitizations backed by single-family residential mortgage loans
("securitization shelves"). From time to time, the Company purchases mortgage
loans from originators or conduits, places these loans into private mortgage
pass-through securities and issues CMOs or other securities backed by these
securities. The Company may or may not retain a significant residual economic
interest in these securitizations. During 2001, Capstead has not issued any
CMOs.
To date, the related credit risk of the securities collateralizing CMOs issued
by Capstead 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 only $737,000 of credit risk held in the form of subordinated bonds
associated with approximately $487 million of these securities outstanding as of
March 31, 2001.
In addition, Capstead has retained $2.7 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 $123 million of loans outstanding
as of March 31, 2001 from the related securitizations. CMO collateral and
investments, net of related bonds, was $21.9 million at March 31, 2001, down
from $23.0 million at December 31, 2000. Included in this net investment are
$16.0 million of the remaining CMO collateral premiums and bond discounts.
Similar to premiums on the Company's mortgage investments, CMO collateral
premiums and bond discounts 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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UTILIZATION OF CAPITAL AND POTENTIAL LIQUIDITY
The Company's utilization of capital and potential liquidity as of March 31,
2001 were as follows (in thousands):
CAPITAL POTENTIAL
ASSETS BORROWINGS EMPLOYED LIQUIDITY
---------- ---------- ---------- ----------
*
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 3,586 $ -- $ 3,586 $ 3,478
Medium-term 103,145 99,240 3,905 811
LIBOR/CMT ARMs 2,159,667 1,969,386 190,281 125,491
COFI ARMs 205,514 132,383 73,131 66,965
GNMA ARMs 2,048,611 1,905,616 142,995 81,537
---------- ---------- ---------- ----------
4,520,523 4,106,625 413,898 278,282
Non-agency Securities 88,149 -- 88,149 83,822
CMBS - adjustable-rate 74,265 61,393 12,872 --
CMO collateral and investments 3,020,161 2,998,224 21,937 --
---------- ---------- ---------- ----------
$7,703,098 $7,166,242 536,856 362,104
========== ========== ========== ==========
Other assets, net of other liabilities 66,368 13,373**
---------- ----------
$ 603,224 $ 375,477
========== ==========
* Based on maximum borrowings available under existing uncommitted
repurchase arrangements considering the fair value of related
collateral as of March 31, 2001 (see "Liquidity and Capital
Resources"). The Company anticipates funding the $200 million special
dividend out of this liquidity.
** Represents cash and cash equivalents.
The Company finances its investments in mortgage securities with investment
banking firms under repurchase arrangements (see "Liquidity and Capital
Resources"). CMO collateral and investments are generally pledged to secure CMO
bonds. Liquidity is affected by, among other things, changes in market value of
securities pledged under repurchase arrangements, principal prepayments and
general conditions in the mortgage finance industry.
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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
----------------------
2001 2000
--------- ---------
Agency Securities $ 19,940 $ 10,920
Non-agency Securities 1,801 1,390
CMBS 553 542
CMO collateral and investments (72) (237)
-------- --------
Net margin on mortgage assets 22,222 12,615
Other revenue (expense):
Gain on sale of mortgage assets 5,863 --
CMO administration and other 719 784
Other operating expense (4,155) (1,729)
-------- --------
Net income $ 24,649 $ 11,670
======== ========
Net income per common share:
Basic $ 0.75 $ 0.22
Diluted 0.69 0.22
The earning capacity of Capstead'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
(see "Financial Condition" for discussion regarding the June 29, 2001 payment of
a $200 million special dividend). Higher net margins on mortgage assets for the
three months ended March 31, 2001 compared to the same period in 2000 reflect
higher yields earned on the mortgage investment portfolio as yields on ARM
securities steadily increased over the past year as coupon interest rates on the
underlying mortgage loans reset higher reflecting the rising interest rate
environment experienced during 2000. Yields were also impacted by the portfolio
restructuring that commenced during the second quarter of last year and resulted
in the sale or designation for sale of nearly all fixed-rate and medium-term
securities previously held in the portfolio and the acquisition of additional
ARM securities. Rates on borrowings under repurchase arrangements during the
current quarter, although nearly flat with rates paid during the first quarter
of 2000, benefited significantly from lower short-term interest rates and
therefore were considerably lower than rates paid later in 2000. See "Financial
Condition - Mortgage Investments" for a forward-looking discussion of the
effects of recent actions taken by the Federal Reserve to lower short-term
interest rates on ARM yields and borrowing rates.
Agency Securities contributed more to operating results during the first quarter
of 2001 than in the same period of 2000 primarily because of higher average
yields. Yields for this portfolio averaged 7.02% during the quarter, compared to
6.11% during the same quarter in 2000, while average borrowing rates were 5.80%
compared to 5.83% in 2000. Average yields benefited as interest rates on
mortgage loans underlying ARM securities reset higher (reflecting higher
prevailing interest rates during much of 2000). Yields also increased with the
restructuring-related sale of relatively low-coupon fixed-rate and medium-term
securities. In addition, yields also benefited from higher yields on newly
acquired ARM securities and on mortgage securities designated for sale in
connection with the portfolio restructuring. The average outstanding Agency
Securities portfolio was $4.8 billion during the current quarter, compared to
$5.2 billion during the same period in 2000.
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21
Non-agency Securities contributed more to operating results during the first
quarter of 2001 despite a lower average outstanding portfolio because of lower
borrowing costs. The average outstanding portfolio was $91 million during the
current quarter, compared to $163 million during the same period in 2000. During
the current quarter, this portfolio was funded almost entirely with equity,
while in the corresponding quarter of 2000, this portfolio was financed with
average borrowings of $119 million. Average yields for this portfolio
(calculated including mortgage insurance costs) were 8.23% during the first
quarter, compared to 7.92% during the same period in 2000.
Capstead made its first acquisitions of credit-sensitive CMBS in December 1999.
Since early 2000, the Company has not made any additions to this portfolio,
which currently consists of $74 million of adjustable-rate CMBS financed by
longer-term repurchase arrangements. These investments yielded 8.35% during the
first quarter while average borrowing rates were 6.35%.
CMO collateral and investments results continue to diminish as the CMO
securitizations that the Company has retained interests in continue to runoff or
are redeemed pursuant to clean-up calls (see "Financial Condition - CMO
Collateral and Investments"). Without 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.
Gain on sale of mortgage assets reflects the sale of $451 million of medium-term
Agency Securities.
CMO administration and other revenue was lower this year primarily because a
declining portfolio of CMOs for which the Company provides administrative
services. As these CMOs pay down, related fee income is expected to decline.
Other operating expenses include higher accruals for incentive compensation
because of the expectation that the Company's performance in 2001 will exceed
predetermined benchmarks established by the Compensation Committee of Capstead's
Board of Directors.
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 REIT and the June 29, 2001 payment of the recently declared special common
dividend. No asset sales are expected to be necessary to fund this dividend. 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 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 purchases of adjustable-rate
CMBS more closely match the interest rate adjustment features and expected life
of these investments such that the Company
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anticipates it can earn consistent net interest spreads on these investments.
Should Capstead make significant additional investments in credit-sensitive
mortgage assets, 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").
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. The sensitivity of CMO administration fee income to changes in
interest rates is included as well. The model incorporates management
assumptions regarding the level of prepayments on mortgage assets for a given
interest rate change using market-based estimates of prepayment speeds for
various coupon segments. These assumptions are developed through a combination
of historical analysis and future expected pricing behavior. As of March 31,
2001, Capstead had the following estimated earnings sensitivity profile (dollars
in thousands):
10-YEAR
30-DAY U.S.
LIBOR TREASURY
RATE RATE IMMEDIATE CHANGE IN:*
------ -------- ---------------------------------------------------
30-day LIBOR rate Down 1.00% Down 1.00% Flat Up 1.00%
10-year U.S. Treasury rate Down 1.00% Flat Up 1.00% Up 1.00%
Projected 12-month
earnings change:**
March 31, 2001 5.08% 4.92% $22,873 $26,380 $4,802 $(16,787)
December 31, 2000 6.56% 5.12% $18,344 $23,447 $4,145 $(22,665)
* Sensitivity of earnings to changes in interest rates is determined
relative to the actual rates at the applicable date.
** Note that the projected 12-month earnings change is predicated on
acquisitions of similar assets sufficient to replace runoff. There can be
no guarantee that suitable investments will be available for purchase at
attractive prices or if investments made will behave in the same fashion
as assets currently held.
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 affect the Company's earnings in various ways.
Earnings currently depend, in part, on the difference between the interest
received on mortgage securities and other investments, and the interest paid on
related borrowings, which are generally based on 30-day LIBOR. The resulting
spread may be reduced or even turn negative in a rising short-term interest rate
environment. Because the mortgage investment portfolio consists primarily of 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 the underlying ARM
loans, which reset periodically based on underlying indices (generally 1-year
CMT rates). Since ARM loans generally limit the amount of such increases during
any single interest rate adjustment period
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23
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, and as is
currently being experienced in 2001, declines in these indices during periods of
falling short-term interest rates will negatively effect yields on ARM
securities as the underlying ARM loans reset at lower rates. If declines in
these indices exceed declines in the Company's borrowing rates, financing
spreads could be lower or even become negative. 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, 2001, the Company did not own
any Derivatives as a hedge against rising short-term 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. 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 premiums. Further, 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.
A change in interest rates also impacts earnings recognized from CMO collateral
and investments, which currently consist primarily of fixed-rate CMO residuals
(see "Financial Condition"). As seen in 1998, if mortgage interest rates fall,
prepayments on the underlying mortgage loans generally will be higher,
accelerating the amortization of collateral premiums and bond discounts.
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 positive net cash flows and can
amortize remaining collateral premiums and bond discounts.
Capstead 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 the second quarter of 2000, asset
sales may become prudent to shift the Company's investment focus.
RISKS ASSOCIATED WITH CREDIT-SENSITIVE INVESTMENTS
Commercial mortgage assets may be viewed as exposing an investor to greater risk
of loss than residential mortgage assets since such assets are typically secured
by larger loans to fewer obligors than residential mortgage assets. Commercial
property values and related net operating income are often subject to
volatility, and such 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 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 be readily 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 often
requires substantial capital expenditures, which may or may not be available.
The availability of credit for commercial mortgage loans may be dependent upon
economic conditions in the markets where such properties are located, as well as
the willingness and ability of lenders to make
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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.
Credit-sensitive residential mortgage assets differ from commercial mortgage
assets 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 commercial mortgage
assets, in instances of default the Company may incur losses if proceeds from
sales of the underlying collateral are less than the unpaid principal balances
of the mortgage loans and related foreclosure costs. However, with residential
mortgage assets 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 mortgage
assets, 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 commercial and residential mortgage assets 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 assets, sufficient capital may not be available to support the continued
ownership of such investments, requiring these assets to be sold at a loss.
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.
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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 Exhibit is presented herewith:
Exhibit 12 - Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends.
(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 7, 2001 By: /s/ ANDREW F. JACOBS
--------------------------------------
Andrew F. Jacobs
Executive Vice President - Finance
Date: May 7, 2001 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.