================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
X EXCHANGE ACT OF 1934
- ------
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2002
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)
<Table>
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)
</Table>
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) 13,879,686 as of April 30, 2002
================================================================================
CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2002
INDEX
<Table>
<Caption>
PAGE
----
ITEM 1. Financial Statements
Consolidated Balance Sheets -- March 31, 2002 and December 31, 2001... 3
Consolidated Statements of Operations -- Quarter Ended March 31, 2002
and 2001............................................................ 4
Consolidated Statements of Cash Flows -- Quarter Ended March 31, 2002
and 2001............................................................ 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 4. Submission of Matters to a Vote of Security Holders........... 25
ITEM 6. Exhibits and Reports on Form 8-K.............................. 25
SIGNATURES .............................................................. 26
</Table>
-2-
ITEM 1. FINANCIAL STATEMENTS
PART I. -- FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
MARCH 31, 2002 DECEMBER 31, 2001
-------------- -----------------
(UNAUDITED)
ASSETS
Mortgage securities and other investments
($3.0 billion pledged under repurchase arrangements) $ 3,189,344 $ 3,455,219
CMO collateral and investments 1,912,857 2,262,305
----------- -----------
5,102,201 5,717,524
Prepaids, receivables and other 43,192 54,381
Receivable from affiliate 4,000 --
Cash and cash equivalents 102,807 123,520
----------- -----------
$ 5,252,200 $ 5,895,425
=========== ===========
LIABILITIES
Repurchase arrangements and other borrowings $ 2,922,300 $ 3,207,068
Collateralized mortgage obligations ("CMOs") 1,898,115 2,245,015
Incentive fee payable to management and affiliate 1,594 9,422
Accounts payable and accrued expenses 7,493 29,192
----------- -----------
4,829,502 5,490,697
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value; 100,000 shares authorized:
$1.60 Cumulative Preferred Stock, Series A,
273 and 273 shares issued and outstanding at
both March 31, 2002 and December 31, 2001,
respectively ($4,472 aggregate liquidation preference) 3,814 3,821
$1.26 Cumulative Convertible Preferred Stock, Series B,
15,842 and 15,842 shares issued and outstanding at
March 31, 2002 and December 31, 2001, respectively
($180,283 aggregate liquidation preference) 176,961 176,961
Common stock - $0.01 par value; 100,000 shares authorized;
13,863 and 13,862 shares issued and outstanding at
March 31, 2002 and December 31, 2001, respectively 139 139
Paid-in capital 559,475 559,571
Accumulated deficit (364,442) (387,718)
Accumulated other comprehensive income 46,751 51,954
----------- -----------
422,698 404,728
----------- -----------
$ 5,252,200 $ 5,895,425
=========== ===========
</Table>
See accompanying notes to consolidated financial statements.
-3-
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
QUARTER ENDED MARCH 31
----------------------
2002 2001
--------- ---------
INTEREST INCOME:
Mortgage securities and other investments $ 45,768 $ 87,542
CMO collateral and investments 37,434 55,785
--------- ---------
Total interest income 83,202 143,327
--------- ---------
INTEREST AND RELATED EXPENSE:
Repurchase arrangements and other borrowings 14,047 65,162
CMO borrowings 37,986 55,615
Mortgage insurance and other 168 328
--------- ---------
Total interest and related expense 52,201 121,105
--------- ---------
Net margin on financial assets 31,001 22,222
--------- ---------
OTHER REVENUE (EXPENSE):
Gain on sale of mortgage assets -- 5,863
CMO administration and other 447 719
Management and affiliate incentive fee (1,594) (2,741)
Other operating expense (1,479) (1,414)
--------- ---------
Total other operating revenue (expense) (2,626) 2,427
--------- ---------
NET INCOME $ 28,375 $ 24,649
========= =========
Net income $ 28,375 $ 24,649
Less cash dividends on preferred stock (5,099) (5,894)
--------- ---------
Net income available to common stockholders $ 23,276 $ 18,755
========= =========
NET INCOME PER COMMON SHARE:
Basic $ 1.68 $ 1.49
Diluted 1.43 1.39
CASH DIVIDENDS DECLARED PER SHARE:
Common $ 1.650 $ 0.980
Series A Preferred 0.400 0.400
Series B Preferred 0.315 0.315
</Table>
See accompanying notes to consolidated financial statements.
-4-
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
QUARTER ENDED MARCH 31
----------------------
2002 2001
--------- ---------
OPERATING ACTIVITIES:
Net income $ 28,375 $ 24,649
Noncash items:
Amortization of discount and premium 7,055 6,990
Depreciation and other amortization 429 268
Gain on sale of mortgage assets -- (5,863)
Net change in prepaids, receivables, other assets, accounts payable
and accrued expenses (22,855) (15,303)
--------- ---------
Net cash provided by operating activities 13,004 10,741
--------- ---------
INVESTING ACTIVITIES:
Purchases of mortgage securities and other investments (69,981) (87,322)
Principal collections on mortgage investments 327,316 363,076
Proceeds from sales of mortgage assets -- 457,182
CMO collateral:
Principal collections 347,159 105,238
Decrease in accrued interest receivable 2,115 663
Increase in short-term investments -- (434)
--------- ---------
Net cash provided by investing activities 606,609 838,403
--------- ---------
FINANCING ACTIVITIES:
Decrease in repurchase arrangements and other borrowings (284,768) (736,614)
CMO borrowings:
Principal payments on securities (348,383) (107,113)
Decrease in accrued interest payable (1,938) (601)
Capital stock transactions (138) (7,310)
Dividends paid (5,099) (5,894)
--------- ---------
Net cash used in financing activities (640,326) (857,532)
--------- ---------
Net change in cash and cash equivalents (20,713) (8,388)
Cash and cash equivalents at beginning of period 123,520 21,761
--------- ---------
Cash and cash equivalents at end of period $ 102,807 $ 13,373
========= =========
</Table>
See accompanying notes to consolidated financial statements.
-5-
CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
NOTE 1 -- BUSINESS
Capstead Mortgage Corporation operates as a real estate investment trust
("REIT") earning income from investing in real estate-related assets on a
leveraged basis and from other investment strategies. These investments
currently include, but are 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"). Capstead has
also made limited investments in credit-sensitive commercial real estate-related
assets that can earn attractive returns due largely to a higher risk of default
and reduced liquidity compared to Agency Securities. The Company continues to
evaluate suitable real estate-related investments, which may include more
credit-sensitive assets, such as direct ownership of real estate (see NOTE 13).
Capstead believes that such investments, when combined with the prudent use of
leverage, can provide attractive returns over the long term with less
sensitivity to changes in interest rates.
Capstead's investment portfolios declined during 2001 and thus far in 2002
primarily because of high levels of mortgage prepayments. To the extent proceeds
of runoff or asset sales are not reinvested, or cannot be reinvested, at a rate
of return at least equal to the rate previously earned on that capital, earnings
may decline. The future size and composition of Capstead's investment portfolios
will depend on market conditions, including levels of mortgage prepayments and
the availability on a timely basis of suitable investments at attractive
pricing.
NOTE 2 -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the quarter ended March 31, 2002 are not
necessarily indicative of the results that may be expected for the calendar year
ending December 31, 2002. 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, 2001.
NOTE 3 -- FIRST QUARTER COMMON DIVIDEND
On April 17, 2002 the Board of Directors declared a first quarter dividend of
$1.65 per common share, payable May 20, 2002 to stockholders of record as of May
7, 2002.
NOTE 4 -- 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
-6-
for antidilutive convertible preferred shares, by the weighted average number of
common shares and common share equivalents outstanding, giving effect to
dilutive stock options and dilutive convertible preferred shares.
For dilutive net income per share purposes, the Series A and B preferred shares
are considered dilutive whenever annualized basic net income per share exceeds
each Series' annualized dividend divided by the conversion rate applicable for
that period. The Series A preferred shares were dilutive during the periods
presented. The Series B preferred shares became dilutive after a new conversion
rate went into effect July 2, 2001, even though few actual Series B conversions
subsequently occurred because it was uneconomical to convert at the market
prices of both the common shares and Series B preferred shares in effect during
the ensuing periods.
The components of the computation of basic and diluted net income per share were
as follows (in thousands, except per share data):
<Table>
<Caption>
QUARTER ENDED MARCH 31
--------------------
2002 2001
-------- --------
NUMERATOR FOR BASIC NET INCOME PER COMMON SHARE:
Net income $ 28,375 $ 24,649
Less all preferred share dividends (5,099) (5,894)
-------- --------
Net income available to common stockholders $ 23,276 $ 18,755
======== ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 13,823 12,557
======== ========
BASIC NET INCOME PER COMMON SHARE $ 1.68 $ 1.49
======== ========
NUMERATOR FOR DILUTED NET INCOME PER COMMON SHARE:
Net income $ 28,375 $ 24,649
Less cash dividends paid on antidilutive convertible preferred shares:
Series A -- --
Series B -- (4,991)
-------- --------
$ 28,375 $ 19,658
======== ========
DENOMINATOR FOR DILUTED NET INCOME PER COMMON SHARE:
Weighted average common shares outstanding 13,823 12,557
Net effect of dilutive stock options 75 78
Net effect of dilutive preferred shares 5,902 1,551
-------- --------
19,800 14,186
======== ========
DILUTED NET INCOME PER COMMON SHARE $ 1.43 $ 1.39
======== ========
</Table>
-7-
NOTE 5 -- MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities and other investments and the related average interest rates
were as follows (dollars in thousands):
<Table>
<Caption>
AVERAGE
PRINCIPAL PREMIUMS CARRYING AVERAGE EFFECTIVE
BALANCE (DISCOUNT) BASIS AMOUNT COUPON RATE
----------- ----------- ------------ ---------- -------- ---------
MARCH 31, 2002 (a) (b) (b)
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 2,107 $ 9 $ 2,116 $ 5,146 10.00% 9.36%
Medium-term 35,851 (141) 35,710 36,831 6.19 6.10
LIBOR/CMT ARMs 1,392,613 22,404 1,415,017 1,437,911 6.43 5.55
COFI ARMs 154,481 (4,475) 150,006 154,963 4.62 5.85
GNMA ARMs 1,222,801 13,121 1,235,922 1,247,241 6.23 5.60
----------- ----------- ----------- -----------
2,807,853 30,918 2,838,771 2,882,092 6.25 5.60
Non-agency securities(c) 93,738 904 94,642 95,849 6.36 6.16
CMBS(c) 171,366 (273) 171,093 171,365 3.58 3.82
Commercial loans(c) 40,000 38 40,038 40,038 8.50 8.47
----------- ----------- ------------ -----------
$ 3,112,957 $ 31,587 $ 3,144,544 $ 3,189,344 6.13 5.55
=========== =========== ============ ===========
DECEMBER 31, 2001
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 5,706 $ 34 $ 5,740 $ 5,981 10.00% 9.29%
Medium-term 40,559 (149) 40,410 41,544 6.19 6.44
LIBOR/CMT ARMs 1,543,867 25,286 1,569,153 1,593,115 6.88 6.59
COFI ARMs 167,080 (4,839) 162,241 168,856 5.31 6.45
GNMA ARMs 1,368,551 14,460 1,383,011 1,398,908 6.37 6.40
----------- ----------- ------------ -----------
3,125,763 34,792 3,160,555 3,208,404 6.57 6.49
Non-agency securities(c) 73,040 373 73,413 74,839 6.94 7.58
CMBS(c) 172,071 (380) 171,691 171,976 3.69 6.46
----------- ----------- ------------ -----------
$ 3,370,874 $ 34,785 $ 3,405,659 $ 3,455,219 6.43 6.52
=========== =========== ============ ===========
</Table>
(a) Includes mark-to-market for securities classified as
available-for-sale, if applicable (see NOTE 9).
(b) 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.
(c) As of the indicated dates, these portfolios consisted of
adjustable-rate investments.
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") and commercial
loans are classified in a similar fashion. Fixed-rate mortgage securities have
fixed rates of interest for their entire 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 the 1-year Constant
Maturity U.S. Treasury Note Rate ("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
initial 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
-8-
semiannually based on a specified margin over the 6-month London Interbank
Offered Rate ("LIBOR"), (iii) adjust monthly based on a specific margin over an
index such as LIBOR or the Cost of Funds Index as published by the Eleventh
District Federal Reserve Bank ("COFI"), or (iv) were previously classified as
medium-term and have begun adjusting annually based on a specified margin over
1-year CMT. CMBS and commercial loans held as of March 31, 2002 adjust monthly
based on a specified margin over 30-day LIBOR.
Agency Securities are AAA-rated and are considered to have limited credit risk.
Non-agency securities consist of (i) private mortgage pass-through securities
backed primarily by single-family non-conforming residential mortgage loans
whereby the related credit risk of the underlying loans is borne by AAA-rated
private mortgage insurers and (ii) other AAA-rated private mortgage securities
(together, "Non-agency Securities"). Commercial mortgage securitizations
generally have senior, mezzanine and subordinate classes of bonds with the lower
bond classes providing credit enhancement to the more senior classes. CMBS held
by the Company at March 31, 2002 are mezzanine classes and therefore carry
credit risk associated with the underlying pools of commercial mortgage loans
that is mitigated by subordinate bonds held by other investors. Commercial loans
held by the Company as of March 31, 2002 consist of a $40 million loan to a
joint venture that holds commercial real estate. 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 primarily fixed-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. The components of CMO collateral and investments were as follows (in
thousands):
<Table>
<Caption>
MARCH 31, 2002 DECEMBER 31, 2001
-------------- -----------------
Pledged CMO Collateral:
Pledged mortgage securities $1,883,849 $2,231,324
Short-term investments 30 30
Accrued interest receivable 11,213 13,329
---------- ----------
1,895,092 2,244,683
Unamortized premium 14,980 14,860
---------- ----------
1,910,072 2,259,543
CMO investments 2,785 2,762
---------- ----------
$1,912,857 $2,262,305
========== ==========
</Table>
Pledged mortgage securities are primarily 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 $249,000 of
credit risk held in the form of subordinated bonds associated with $204 million
of Pledged CMO Collateral outstanding at March 31, 2002. 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 $81 million of loans outstanding as of March 31, 2002 from the
related securitizations. The weighted average effective interest rate for total
Pledged CMO Collateral was 7.27% during the quarter ended March 31, 2002.
-9-
NOTE 7 -- REPURCHASE ARRANGEMENTS AND OTHER BORROWINGS
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 initial
maturities and may feature renewal options. Other borrowings at March 31, 2002
are secured by the Company's recent commercial loan investment. This
adjustable-rate loan with a commercial bank matures in January 2005. The terms
and conditions of repurchase arrangements and other borrowings are negotiated on
a transaction-by-transaction basis. Repurchase arrangements, classified by type
of collateral and maturities, other borrowings and related weighted average
interest rates for the dates indicated, were as follows (dollars in thousands):
<Table>
<Caption>
MARCH 31, 2002 DECEMBER 31, 2001
----------------------------- ---------------------------
BORROWINGS AVERAGE BORROWINGS AVERAGE
OUTSTANDING RATE OUTSTANDING RATE
------------- ----------- ------------ -----------
Repurchase arrangements:
Agency Securities (less than 31 days) $2,691,942 1.83% $2,999,860 1.88%
Non-agency Securities (less than 31
days) 49,518 1.96 55,602 2.05
CMBS (less than 1 year) 150,840 2.17 151,606 2.23
---------- ----------
2,892,300 1.85 3,207,068 1.90
Other borrowings 30,000 4.38 -- --
---------- ----------
$2,922,300 1.87 $3,207,068 1.90
========== ==========
</Table>
The weighted average effective interest rate on repurchase arrangements and
other borrowings was 1.84% during the quarter ended March 31, 2002.
NOTE 8 -- 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 were as follows (dollars in thousands):
<Table>
<Caption>
MARCH 31, 2002 DECEMBER 31, 2001
-------------- -----------------
CMOs $1,881,024 $2,228,091
Accrued interest payable 10,315 12,253
------------- -------------
Total obligation 1,891,339 2,240,344
Unamortized premium 6,776 4,671
-------------- --------------
$1,898,115 $2,245,015
========== ==========
Range of average interest rates 2.26% to 9.56% 2.29% to 9.45%
Range of stated maturities 2008 to 2030 2008 to 2030
Number of series 18 19
</Table>
-10-
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 weighted average effective interest
rate for all CMOs was 7.45% during the quarter ended March 31, 2002.
NOTE 9 -- 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.
Commercial loans and other financial instruments not held in the form of debt or
equity securities are excluded from these disclosures.
The following table summarizes fair value disclosures for available-for-sale
debt securities (in thousands):
<Table>
<Caption>
GROSS GROSS
COST UNREALIZED UNREALIZED FAIR
BASIS GAINS LOSSES VALUE
------------ ---------- ---------- -----------
AS OF MARCH 31, 2002
Agency Securities:
Fixed-rate $ 2,116 $ 188 $ -- $ 2,304
Medium-term 35,710 1,121 -- 36,831
ARMs 2,798,103 42,142 130 2,840,115
---------- ---------- ---------- ----------
2,835,929 43,451 130 2,879,250
Non-agency Securities 93,931 1,210 3 95,138
CMBS 171,093 272 -- 171,365
CMO collateral and investments 37,892 1,185 41 39,036
---------- ---------- ---------- ----------
$3,138,845 $ 46,118 $ 174 $3,184,789
========== ========== ========== ==========
AS OF DECEMBER 31, 2001
Agency Securities:
Fixed-rate $ 2,596 $ 241 $ -- $ 2,837
Medium-term 40,410 1,134 -- 41,544
ARMs 3,114,405 46,680 206 3,160,879
---------- ---------- ---------- ----------
3,157,411 48,055 206 3,205,260
Non-agency Securities 72,458 1,426 -- 73,884
CMBS 171,691 285 -- 171,976
CMO collateral and investments 44,644 1,491 38 46,097
---------- ---------- ---------- ----------
$3,446,204 $ 51,257 $ 244 $3,497,217
========== ========== ========== ==========
</Table>
-11-
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 Agency or Non-agency Securities. Fair value disclosures for debt
securities held-to-maturity were as follows (in thousands):
<Table>
<Caption>
GROSS GROSS
COST UNREALIZED UNREALIZED FAIR
BASIS GAINS LOSSES VALUE
---------- ---------- ---------- ----------
AS OF MARCH 31, 2002
Released CMO Collateral:
Agency Securities $ 2,842 $ 246 $ -- $ 3,088
Non-agency Securities 711 64 -- 775
Pledged CMO Collateral 1,873,821 1,155 8,444 1,866,532
---------- ---------- ---------- ----------
$1,877,374 $ 1,465 $ 8,444 $1,870,395
========== ========== ========== ==========
AS OF DECEMBER 31, 2001
Released CMO Collateral:
Agency Securities $ 3,144 $ 285 $ -- $ 3,429
Non-agency Securities 955 88 -- 1,043
Pledged CMO Collateral 2,216,208 1,455 10,084 2,207,579
---------- ---------- ---------- ----------
$2,220,307 $ 1,828 $ 10,084 $2,212,051
========== ========== ========== ==========
</Table>
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):
<Table>
<Caption>
QUARTER ENDED MARCH 31
---------------------------
2002 2001
--------- -------
Sale of securities held available-for-sale:
Amortized cost $ -- $451,319
Gain -- 5,863
</Table>
NOTE 10 -- COMPREHENSIVE INCOME
Comprehensive income 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 Statement of Financial Accounting Standards No. 133 "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). The following table
provides information regarding comprehensive income (in thousands):
<Table>
<Caption>
QUARTER ENDED MARCH 31
--------------------
2002 2001
-------- --------
Net income $ 28,375 $ 24,649
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 (130) (372)
Reclassification adjustment for gain included in net income (4) (13)
-------- --------
(134) 980
Unrealized gain (loss) on debt securities:
Change in unrealized gain (loss) during period (5,069) 25,752
Reclassification adjustment for gain included in net income -- (5,863)
-------- --------
Other comprehensive income (loss) (5,203) 20,869
-------- --------
Comprehensive income $ 23,172 $ 45,518
======== ========
</Table>
-12-
NOTE 11 -- NET INTEREST INCOME ANALYSIS
The following summarizes interest income and interest expense and weighted
average interest rates (dollars in thousands):
<Table>
<Caption>
QUARTER ENDED MARCH 31
-----------------------------------------------------------
2002 2001
--------------------------- --------------------------
AVERAGE AVERAGE
EFFECTIVE EFFECTIVE
AMOUNT RATE AMOUNT RATE
---------- ---------- ---------- ----------
Interest income:
Mortgage securities and other investments $45,768 5.55% $87,542 7.06%
CMO collateral and investments 37,434 7.27 55,785 7.30
------- -------
Total interest income 83,202 143,327
------- -------
Interest expense:
Repurchase arrangements and other borrowings 14,047 1.84 65,162 5.81
CMO borrowings 37,986 7.45 55,615 7.33
------- -------
Total interest expense 52,033 120,777
------- -------
$31,169 $22,550
======= =======
</Table>
Changes in interest income and interest expense due to changes in interest rates
versus changes in volume were as follows (in thousands):
<Table>
<Caption>
RATE* VOLUME* TOTAL
-------- -------- --------
Interest income:
Mortgage securities and other investments $(16,288) $(25,486) $(41,774)
CMO collateral and investments (281) (18,070) (18,351)
-------- -------- --------
Total interest income (16,569) (43,556) (60,125)
-------- -------- --------
Interest expense:
Repurchase arrangements and other borrowings (34,814) (16,301) (51,115)
CMO borrowings 896 (18,525) (17,629)
-------- -------- --------
Total interest expense (33,918) (34,826) (68,744)
-------- -------- --------
$ 17,349 $ (8,730) $ 8,619
======== ======== ========
</Table>
* 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 12 -- 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, the court appointed a lead plaintiff group. An amended
complaint was filed in October 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. In February 2001 the Company responded to this amended
complaint with a motion to dismiss all allegations against the Company and the
named officers. In April 2001 the plaintiffs responded to the Company's motion
to dismiss and the Company filed its reply to the plaintiffs' response in May
2001. The Company believes it has meritorious
-13-
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.
NOTE 13 -- TRANSACTIONS WITH AFFILIATES
Fortress Investment Group, LLC (together with its affiliates, "Fortress") is
Capstead's largest stockholder controlling over 26% of the Company's outstanding
common shares. Through a management contract, Fortress provides the services of
Wesley R. Edens (Fortress' chairman of the board and chief executive officer) as
Capstead's chairman and chief executive and of other individuals as necessary to
perform support services for Mr. Edens. Under the terms of this contract,
Fortress is entitled to a $375,000 base annual fee and a cash management
incentive fee. Included in Other operating expense is $93,750 of base fees paid
to Fortress for services rendered during the three months ended March 31, 2002
and 2001, respectively. Fortress' incentive fees are included in Management and
affiliate incentive fees which are based on the Company's expected performance
against predetermined benchmarks established by members of the Board of
Directors independent of Fortress.
In connection with the potential purchase of a portfolio of senior living
properties from an independent third party, the Company advanced to an affiliate
of Fortress (referred to as "Brookdale"), as contract purchaser, $4.0 million to
be held in escrow by the third party and applied towards the purchase price. It
is anticipated that Brookdale will assign its interests to the purchase
contract, including the escrow, to Capstead prior to closing. The aggregate
purchase price of the properties is expected to be approximately $139 million
plus closing costs, including the assumption of $122 million of related mortgage
and tax-exempt bond debt. The transaction is expected to close in the second
calendar quarter of 2002 at which time the Company anticipates entering into a
long term net lease agreement with Brookdale, under which Brookdale will be
responsible for the ongoing operation of the properties.
-14-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
Capstead Mortgage Corporation ("Capstead" or the "Company") operates as a real
estate investment trust ("REIT") earning income from investing in real
estate-related assets on a leveraged basis and from other investment strategies.
These investments currently include, but are 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"). The Company has also made limited investments in
credit-sensitive, commercial real estate-related assets that can earn attractive
returns due largely to a higher risk of default and reduced liquidity compared
to Agency Securities. As existing investments prepay or mature, Capstead has the
opportunity to continue to reinvest a portion of its equity capital into
investments that can produce attractive returns over the long term, with less
sensitivity to changes in interest rates than Agency Securities. To this end,
the Company continues to actively evaluate suitable real estate-related
investments, which may include more credit-sensitive assets, such as the direct
ownership of real estate. There can be no assurance that suitable investments at
attractive pricing will be available on a timely basis to replace portfolio
runoff as it occurs (see "Effects of Interest Rate Changes" and "Risks
Associated with Credit-Sensitive Investments").
At March 31, 2002 book value per common share was $14.23, compared to $14.59 at
December 31, 2001, (calculated excluding the $1.65 first quarter 2002 common
dividend declared April 17, 2002, and assuming redemption of the Series A and B
preferred shares). The decline in book value since year end reflects the impact
of the decline in size of the Company's investment portfolios that consist
primarily of mortgage-backed securities classified as held available-for-sale
and marked-to-market through stockholders' equity. The market value of these
investments can be expected to continue to decline with runoff and to fluctuate
with changes in interest rates and market liquidity, and such changes will be
reflected in book value per common share. Book value will also be affected by
other factors, including the level of dividend distributions; however, temporary
changes in market values of other real estate-related investments not held in
the form of debt or equity securities generally will not affect book value.
MORTGAGE SECURITIES AND OTHER INVESTMENTS
As of March 31, 2002, mortgage securities and other investments consisted
primarily of high quality single-family residential mortgage-backed securities,
most of which are adjustable-rate mortgage ("ARM") Agency Securities (see "NOTE
5" to the accompanying consolidated financial statements for further discussion
of how the Company classifies its mortgage securities and other investments).
Agency Securities are AAA-rated and are considered to have limited credit risk.
Non-agency securities consist of (i) private mortgage pass-through securities
whereby the related credit risk of the underlying loans is borne by AAA-rated
private mortgage insurers and (ii) other AAA-rated private mortgage securities
(together, "Non-agency Securities"). Commercial mortgage-backed securitizations
("CMBS") generally have senior, mezzanine and subordinate classes of bonds with
the lower classes providing credit enhancement to the more senior classes. CMBS
held by the Company at March 31, 2002 are mezzanine classes and therefore carry
credit risk associated with the underlying pools of commercial mortgage loans
that is mitigated by subordinate bonds held by other investors. Commercial loans
held by the Company at March 31, 2002 consist of a $40 million loan to a joint
venture that holds commercial real estate (see "Risks Associated With
Credit-Sensitive Investments").
Mortgage securities are financed under repurchase arrangements with investment
banking firms pursuant to which the portfolios are pledged as collateral.
Capstead financed its commercial loan investment with
-15-
a $30 million loan from a commercial bank. Should the Company acquire other
investments that are not mortgage-backed securities, similar financing
arrangements with other parties, such as commercial banks, may be employed (see
"Liquidity and Capital Resources").
The Company's investment portfolios declined during the first quarter of 2002 to
$3.2 billion from $3.5 billion at December 31, 2001, primarily as a result of
portfolio runoff caused by mortgage prepayments. Although still at elevated
levels, mortgage prepayment rates began to moderate during the first quarter
2002 as interest rates on a substantial portion of the mortgage loans underlying
the Company's ARM securities have already reset to levels at or below most
current mortgage rates, reducing or eliminating the advantage for these
homeowners to refinance. Prepayments should continue to moderate as the
remaining loans reset to lower levels. To the extent the proceeds of mortgage
prepayments and other maturities are not reinvested or cannot be reinvested at a
rate of return on invested capital at least equal to the return earned on
previous investments, earnings may decline. The future size and composition of
the Company's investment portfolios 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").
The following yield and cost analysis illustrates results achieved during the
first quarter 2002 for components of the Company's investment portfolios and
anticipated second quarter 2002 asset yields and borrowing rates as first
projected by the Company on April 17, 2002 (the date first quarter 2002 results
were released and based on interest rates in effect at that date) (dollars in
thousands):
<Table>
<Caption>
1ST QUARTER AVERAGE AS OF MARCH 31, 2002
--------------------------------- --------------------------
PROJECTED LIFETIME
ACTUAL ACTUAL PREMIUMS 2ND QUARTER PREPAYMENT
BASIS YIELD/COST RUNOFF (DISCOUNTS) BASIS YIELD/COST ASSUMPTIONS
----------- ---------- -------- ----------- ----------- ------------ ------------
(a) (a) (b) (b)
Agency securities:
FNMA/FHLMC:
Fixed-rate $ 5,396 9.36% 44% $ 9 $ 2,116 9.50% 25%
Medium-term 38,147 6.10 39 (141) 35,710 6.08 30
ARMs:
LIBOR/CMT 1,495,419 5.55 34 22,404 1,415,017 5.16 40
COFI 157,215 5.85 27 (4,475) 150,006 4.95 18
GNMA ARMs 1,310,865 5.60 37 13,121 1,235,922 5.44 26
----------- ------- -----------
3,007,042 5.60 35 30,918 2,838,771 5.29 33
Non-agency securities 88,772 6.16 33 904 94,642 5.85 35
CMBS and other commercial
loans 198,027 4.44 2 (235) 211,131 4.91 -
----------- ------- -----------
3,293,841 5.55 33 $31,587 3,144,544 5.28 30
=======
Borrowings 3,050,883 1.84 2,922,300 1.89
----------- -----------
Capital employed/
financing spread $ 242,958 3.71 $ 222,244 3.39
=========== ===========
Return on assets (c) 3.84 3.57
</Table>
(a) Basis represents the Company's investment before unrealized gains and
losses. Actual asset yields, runoff rates, borrowing rates and resulting
financing spread are presented on an annualized basis.
(b) Projected annualized yields for the second quarter of 2002 reflect ARM
coupon resets and lifetime prepayment assumptions as adjusted for
expected prepayments for this quarter only, as of April 17, 2002. 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.
(c) The Company uses its liquidity to pay down borrowings. Return on assets
is calculated on an annualized basis assuming the use of this liquidity
to reduce borrowing costs (see "Utilization of Capital and Potential
Liquidity").
-16-
The overall yield earned on the Company's investment portfolios, which currently
consist largely of ARM securities, declined 31 basis points to 5.55% during the
first quarter of 2002. Yields on ARM securities fluctuate as coupon interest
rates on the underlying mortgage loans reset to reflect current interest rates
and are expected to continue to decline in the coming quarters. For example, if
interest rates stabilize at rates in effect on April 17, 2002 (the date first
quarter 2002 results were released), the average yield on the Company's current
investment portfolios could decline a total of 112 basis points by the first
quarter of 2003. Actual yields will depend on fluctuations in, and market
expectations for fluctuations in, interest rates and levels of mortgage
prepayments (see "Effects of Interest Rate Changes").
After having reduced the Federal Funds Rate by a total of 475 basis points
during 2001 to the lowest levels in four decades, the Federal Reserve changed
its bias on monetary policy to a neutral stance at its March 19, 2002 meeting,
an indication that the U.S. economy is showing signs of strength and future
economic growth that may lead to higher short-term interest rates. Consequently,
although the Company's average borrowing rates are currently expected to be
little changed in the second quarter of 2002 from the first quarter, they may
increase in the second half of the year. The Company's borrowing rates depend on
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
changes in financial market liquidity (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. From time to
time the Company may purchase mortgage loans from originators or conduits, place
these loans into private mortgage pass-through securities and issue CMOs or
other securities backed by these securities. The Company may or may not retain a
significant residual economic interest in these securitizations. Most of the
Company's securitizations have been afforded financing accounting treatment with
the related collateral recorded as pledged CMO collateral and the outstanding
bonds recorded as CMO liabilities (referred to as "financed CMOs"). Other
securitizations issued by the Company in 1993 and prior were treated as sales
transactions (referred to as "sold CMOs"). During the first quarter of 2002, the
Company did not issue any CMOs. From time to time, the Company exercises its
right to redeem previously issued CMOs (referred to as "clean-up calls") and
either sell or hold the released collateral for investment. During the first
quarter of 2002, the Company exercised clean-up calls related to two sold CMOs
acquiring $30 million of adjustable-rate securities released from the related
indentures.
Credit risk associated with pledged CMO collateral is borne by AAA-rated private
mortgage insurers or by subordinated bonds usually sold to investors. As of
March 31, 2002, the Company had $249,000 of credit risk held in the form of
subordinated bonds retained by the Company associated with $204 million of
outstanding pledged CMO collateral. In connection with two 1993 sold CMOs,
Capstead retained $2.8 million of reserve funds that are available to pay
special hazard costs (e.g. earthquake or mudslide-related losses) or certain
bankruptcy costs associated with $81 million of loans outstanding as of March
31, 2002. Other than clean-up call rights, the Company does not hold any other
interests in sold CMOs.
CMO collateral and investments, net of related bonds, was $14.7 million at March
31, 2002, down from $17.3 million at year-end 2001. Included in this net
investment are $8.2 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").
-17-
UTILIZATION OF CAPITAL AND POTENTIAL LIQUIDITY
The Company's utilization of capital and potential liquidity as of March 31,
2002 were as follows (in thousands):
<Table>
<Caption>
CAPITAL POTENTIAL
ASSETS BORROWINGS EMPLOYED LIQUIDITY
---------- ---------- -------- ---------
(a)
Mortgage securities and other
investments:
Agency securities $2,882,092 $2,691,942 $190,150 $108,961
Non-agency securities 95,849 49,518 46,331 41,599
CMBS and other commercial loans 211,403 180,840 30,563 1,618
---------- ---------- -------- --------
3,189,344 2,922,300 267,044 152,178
CMO collateral and investments 1,912,857 1,898,115 14,742 --
---------- ---------- -------- --------
$5,102,201 $4,820,415 281,786 152,178
========== ==========
Other assets, net of other liabilities 140,912 102,807(b)
First quarter common dividend(c) (22,937) (22,937)
-------- --------
$399,761 $232,048
======== ========
</Table>
(a) Based on maximum borrowings available under existing uncommitted repurchase
arrangements considering the fair value of related collateral as of
December 31, 2001 (see "Liquidity and Capital Resources").
(b) Represents cash and cash equivalents.
(c) The first quarter common dividend was declared April 17, 2002 and is
payable May 20, 2002 to stockholders of record as of May 7, 2002.
The Company generally finances its mortgage securities and other investments
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 assets pledged under borrowing arrangements, principal
prepayments and general conditions in the investment banking, mortgage finance
and real estate industries. Future levels of financial leverage will be
dependent upon many factors, including the size and composition of the Company's
investment portfolios (see "Liquidity and Capital Resources" and "Effects of
Interest Rate Changes").
-18-
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):
<Table>
<Caption>
QUARTER ENDED MARCH 31
----------------------
2002 2001
------- -------
Agency Securities $29,357 $19,940
Non-agency Securities 1,107 1,801
CMBS and other commercial loans 1,172 553
CMO collateral and investments (635) (72)
------- -------
Net margin on financial assets 31,001 22,222
Other revenue (expense):
Gain on sale of mortgage assets -- 5,863
CMO administration and other 447 719
Management affiliate incentive fee (1,594) (2,741)
Other operating expense (1,479) (1,414)
------- -------
Net income $28,375 $24,649
======= =======
Net income per common share:
Basic $ 1.68 $ 1.49
Diluted 1.43 1.39
Operating* 1.65 0.97
</Table>
* Operating income per common share is calculated excluding gain (loss)
on sale of mortgage assets and the dilutive effects of the Series B
preferred shares. See NOTE 4 to the accompanying interim financial
statements for discussion regarding the impact on the calculation of
diluted net income per share of adjustments effective July 2, 2001 to
preferred share conversion rates.
The earning capacity of Capstead's mortgage asset portfolios is influenced by
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. Net margins on
financial assets and financing spreads (the difference between yields earned on
investments and the rates charged on related borrowings) benefited over the last
15 months from actions taken by the Federal Reserve during 2001 to aggressively
lower short-term interest rates, which resulted in lower interest rates on the
Company's borrowings. During this same period, declining interest rates also led
to declining yields on the Company's adjustable-rate assets and increasing
mortgage prepayment rates reflecting refinancing opportunities available to many
homeowners. Net margins and spreads are expected to decline in 2002 as yields on
the Company's ARM securities continue resetting lower and portfolio balances
continue running off because of relatively high mortgage prepayment rates.
Additionally, a strengthening U.S. economy may lead to increases in short-term
interest rates, which may increase borrowing rates in the second half of the
year. See "Financial Condition - Mortgage Securities and Other Investments" for
further discussion of the effects on ARM yields and borrowing rates of actions
taken by the Federal Reserve to lower short-term interest rates and the
Company's goals regarding redeploying capital made available by portfolio
runoff.
Agency Securities contributed more to operating results during the first quarter
of 2002 than in the same period of 2001 primarily because of lower borrowing
rates, despite lower yields and a significantly lower average outstanding
portfolio. Yields for this portfolio were lower averaging 5.60% during the
current
-19-
quarter, compared to 7.02% during the same quarter in 2001, while average
borrowing rates were 1.81% compared to 5.80% in 2001. The average outstanding
Agency Securities portfolio was $3.0 billion during the current quarter,
compared to $4.8 billion during the same period in 2001.
Non-agency Securities contributed less to operating results during the first
quarter of 2002 than in the same period of 2001 because of higher borrowing
costs. Borrowing costs were higher because this portfolio was funded almost
entirely with equity during the first six months of 2001. Yields for this
portfolio (calculated including mortgage insurance costs) were lower averaging
6.16% during the current quarter, compared to 8.23% during the same quarter in
2001, while average borrowing rates were 1.97% compared to 6.55% in 2001. The
average outstanding portfolio was $89 million during the current quarter,
compared to $91 million during the same period in 2001, while average borrowings
were $53 million compared to $4 million in 2001.
CMBS and other commercial loans contributed more to operating results during the
first quarter of 2002 than in the same period of 2001 primarily because of
portfolio additions. In December 2001 the Company acquired $101 million of
adjustable-rate CMBS and early in 2002 acquired a $40 million adjustable-rate
commercial loan bringing capital deployed into this portfolio to $31 million at
quarter end. The average outstanding portfolio was $198 million during the
current quarter, compared to $74 million during the same period in 2001 while
average borrowings were $171 million compared to $62 million in 2001. The
portfolio yielded 4.44% during the current quarter while borrowing rates
averaged 2.40% producing a financing spread of 2.04%. This compares with yields
of 8.35% and borrowing rates of 6.35% for a spread of 2.00% during the same
quarter of 2001. Because this portfolio currently consists of adjustable-rate
assets secured by borrowings with similar interest rate adjustment features,
future changes in interest rates should have little effect on financing spreads.
CMO collateral and investments results continue to diminish as the CMO
securitizations 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.
CMO administration revenue was lower for the current quarter 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. In
addition, Other revenue benefited less from investing excess liquidity in
short-term investments to take advantage of positive spreads between interest
rates on overnight investments and short-term borrowing rates.
Management and affiliate incentive fee accruals were lower for the current
quarter reflecting current year expectations for the amount the Company's
performance will exceed predetermined benchmarks established by the members of
the Board of Directors that are independent of Fortress.
LIQUIDITY AND CAPITAL RESOURCES
Capstead'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 Potential Liquidity"). The Company currently believes that these
funds are sufficient for the acquisition of real estate-related investments,
repayments on borrowings and the payment of cash dividends as required for
Capstead's continued qualification as a REIT. It is the Company's policy to
remain strongly capitalized and conservatively leveraged.
-20-
Borrowings under repurchase arrangements secured by Agency Securities and
Non-agency Securities generally have maturities of less than 31 days. These
borrowings totaled approximately $2.7 billion at March 31, 2002. Capstead has
uncommitted repurchase facilities with investment banking firms to finance these
investments, subject to certain conditions. Interest rates on these borrowings
are generally based on overnight to 30-day London Interbank Offered Rate
("LIBOR") rates and related terms and conditions 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, credit quality and
liquidity conditions within the investment banking, mortgage finance and real
estate industries (see "Effects of Interest Rate Changes").
Borrowings secured by purchases of adjustable-rate commercial mortgage assets
more closely match the interest rate adjustment features of these investments
such that the Company anticipates it can earn more consistent financing spreads
and, as a result, experience less interest rate volatility than experienced with
the Company's other mortgage investments. These borrowings, which generally have
longer initial maturities than borrowings secured by Agency Securities and may
feature renewal options, totaled approximately $150 million at March 31, 2002.
Should Capstead make significant additional investments in credit-sensitive real
estate-related assets, it is anticipated that it 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").
CMO borrowings totaled approximately $1.9 billion at March 31, 2002 and are
secured by CMO collateral pledged to the related indentures. As such, recourse
is limited to this collateral and therefore has a limited impact on Capstead's
liquidity and capital resources. The maturity of each CMO series is affected by
mortgage prepayments and clean-up calls.
The Company's recent $40 million commercial loan investment has been pledged to
secure a $30 million loan from a commercial bank that matures in December 2004.
Borrowings from sources such as commercial banks may be used to finance other
real estate-related investments the Company may make in 2002. The terms and
conditions of such borrowings will be negotiated on a transaction-by-transaction
basis and can be expected to be similar to the terms and conditions on the
Company's borrowings secured by commercial mortgage assets.
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 can reasonably
be expected to have on future earnings. All mortgage assets and Derivatives
held, if any, are included in this analysis. The sensitivity of Other revenue
(expense) to changes in interest rates is included as well, although no asset
sales are assumed. The model incorporates management assumptions regarding the
level of mortgage prepayments for a given interest rate change using
market-based estimates of prepayment speeds for purposes of amortizing purchase
premiums and CMO bond discounts. These assumptions are developed through a
combination of historical analysis and future expected pricing behavior.
-21-
As of March 31, 2002, Capstead had the following estimated earnings sensitivity
profile (dollars in thousands):
<Table>
<Caption>
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, 2002 1.88% 5.40% $10,262 $14,782 $3,847 $(10,740)
December 31, 2001 1.87 5.05 12,380 18,023 3,196 (14,771)
</Table>
* 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 the 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 mortgage prepayment rates,
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 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 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 only a portion
of the ARM loans underlying the Company's securities reset each month, and the
terms of an ARM loan 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, declines in these indices during periods of relatively low
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, earnings could be adversely affected.
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,
2002 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. During periods of relatively low
interest rates, 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 are not
-22-
reinvested or cannot be reinvested at a rate of interest at least equal to the
rate previously earned on that capital, earnings may be adversely affected.
There can be no assurance that suitable investments at attractive pricing will
be available on a timely basis to replace runoff as it occurs or that the
current composition of investments (consisting primarily of ARM Agency
Securities) will be maintained.
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"). During periods of relatively low mortgage interest
rates, 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, asset sales may become prudent to shift the
Company's investment focus. During periods of rising interest rates or
contracting market liquidity, mortgage asset values can decline leading to
increased margin calls, reducing the Company's liquidity. A margin call means
that a lender requires a borrower to pledge additional collateral to
re-establish the agreed-upon ratio of the value of the collateral to the amount
of the borrowing. If the Company is unable or unwilling to pledge additional
collateral, lenders can liquidate the collateral under adverse market
conditions, likely resulting in losses.
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 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 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.
-23-
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 residential 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
mortgages, in instances of default the Company may incur losses if proceeds from
sales of the underlying residential collateral are less than the unpaid
principal balances of the residential mortgage loans and related foreclosure
costs. However, with residential mortgages 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 lower credit
ratings, higher yields 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 even lower
credit ratings and higher yields 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 may be diminished
during periods of mortgage finance market illiquidity. 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.
-24-
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The annual meeting of stockholders was held April 17, 2002.
(b) The board members included in (c) below were elected to Capstead's
Board of Directors (constituting the entire Board of Directors).
(c) The following items were voted on at the annual meeting:
<Table>
<Caption>
WITHHELD/
FOR ABSTENTIONS
---------- -----------
o Election of board members:
Wesley R. Edens 12,304,266 131,996
Robert I. Kauffman 12,300,545 135,717
Paul M. Low 12,274,252 162,010
Michael G. O'Neil 12,284,756 151,506
Howard Rubin 12,307,536 128,726
Mark S. Whiting 12,309,569 126,693
o Other matters (no other matters)
</Table>
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.
-25-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CAPSTEAD MORTGAGE CORPORATION
Date: April 30, 2002 By: /s/ ANDREW F. JACOBS
-----------------------------------
Andrew F. Jacobs
Executive Vice President - Finance
Date: April 30, 2002 By: /s/ PHILLIP A. REINSCH
-----------------------------------
Phillip A. Reinsch
Senior Vice President - Control
-26-
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
12 - Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends.
</Table>