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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: JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ______________
COMMISSION FILE NUMBER: 1-8996
CAPSTEAD MORTGAGE CORPORATION
(Exact name of Registrant as specified in its Charter)
MARYLAND 75-2027937
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8401 N CENTRAL EXPRESSWAY, SUITE 800, DALLAS, TX 75225
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 874-2323
2711 NORTH HASKELL AVENUE, SUITE 900, DALLAS, TX 75204
------------------------------------------------------
(Former name, former address and former fiscal year,
if changed from last report)
The Registrant meets the conditions set forth in General Instruction H(1)(a) and
(b) for Form 10-Q and is therefore filing this Form under the reduced disclosure
format.
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date.
Common Stock ($0.01 par value) 57,626,820 as of August 13, 1999
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CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1999
INDEX
PART I. -- FINANCIAL INFORMATION
PAGE
ITEM 1. Financial Statements
Consolidated Balance Sheet -- June 30, 1999 and December 31, 1998......................................... 3
Consolidated Statement of Operations -- Quarter and Six Months Ended
June 30, 1999 and 1998................................................................................. 4
Consolidated Statement of Cash Flows -- Six Months Ended June 30, 1999 and 1998........................... 5
Notes to Consolidated Financial Statements................................................................ 6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............................................... 14
ITEM 3. Qualitative and Quantitative Disclosure of Market Risk...................................... 23
ITEM 4. Submission of Matters to a Vote of Security Holders......................................... 24
PART II. -- OTHER INFORMATION
ITEM 5. Other Information........................................................................... 24
ITEM 6. Exhibits and Reports on Form 8-K............................................................ 24
SIGNATURES................................................................................................ 25
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PART I. -- FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ITEM 1. FINANCIAL STATEMENTS
June 30, 1999 December 31, 1998
------------- -----------------
(unaudited)
ASSETS
Mortgage securities and other investments $ 5,583,770 $ 2,369,602
CMO collateral and investments 3,670,663 4,571,274
----------- -----------
9,254,433 6,940,876
Prepaids, receivables and other 56,179 59,526
Cash and cash equivalents 19,289 73,385
Restricted cash 8,500 26,500
----------- -----------
$ 9,338,401 $ 7,100,287
=========== ===========
LIABILITIES
Short-term borrowings $ 5,045,608 $ 1,839,868
Collateralized mortgage obligations 3,636,020 4,521,324
Accounts payable and accrued expenses 18,131 58,894
----------- -----------
8,699,759 6,420,086
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value; 100,000 shares authorized:
$1.60 Cumulative Preferred Stock, Series A, issued and
outstanding, 374 shares in 1999 and 1998
($6,134 aggregate liquidation preference) 5,228 5,228
$1.26 Cumulative Convertible Preferred Stock, Series B,
issued and outstanding, 16,943 shares in 1999 and 17,298
shares in 1998 ($192,811 aggregate liquidation preference) 189,234 193,196
Common stock - $0.01 par value; 100,000 shares authorized;
issued and outstanding, 58,339 shares in 1999 and 60,546
shares in 1998 583 605
Paid-in capital 776,394 787,677
Undistributed income (loss) (294,268) (305,287)
Accumulated other comprehensive income (loss) (38,529) (1,218)
----------- -----------
638,642 680,201
----------- -----------
$ 9,338,401 $ 7,100,287
=========== ===========
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Quarter Ended Six Months Ended
June 30 June 30
------------------------ ------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
INTEREST INCOME:
Mortgage securities and other investments $ 78,150 $ 104,213 $ 125,462 $ 202,997
CMO collateral and investments 68,041 97,658 145,071 191,893
--------- --------- --------- ---------
Total interest income 146,191 201,871 270,533 394,890
--------- --------- --------- ---------
INTEREST AND RELATED EXPENSE:
Short-term borrowings:
Mortgage securities and other investments 60,327 95,429 94,241 183,839
CMO investments -- 10,997 -- 22,323
Collateralized mortgage obligations 67,915 83,950 145,432 161,753
Mortgage insurance and other 522 982 1,149 2,094
--------- --------- --------- ---------
Total interest and related expense 128,764 191,358 240,822 370,009
--------- --------- --------- ---------
Net margin on mortgage assets and other investments 17,427 10,513 29,711 24,881
--------- --------- --------- ---------
NET MARGIN ON MORTGAGE BANKING OPERATIONS -- (27,153) -- (12,308)
OTHER OPERATING REVENUE (EXPENSE):
Gain (loss) on sale of mortgage assets and
related derivative financial instruments -- (251,207) 1,738 (244,444)
CMO administration and other 903 1,066 2,373 2,001
Other operating expenses (1,647) (1,351) (3,232) (3,192)
--------- --------- --------- ---------
Total other operating revenue (expense) (744) (251,492) 879 (245,635)
--------- --------- --------- ---------
NET INCOME (LOSS) $ 16,683 $(268,132) $ 30,590 $(233,062)
========= ========= ========= =========
Net income (loss) $ 16,683 $(268,132) $ 30,590 $(233,062)
Less cash dividends on preferred stock (5,725) (5,589) (11,409) (11,144)
--------- --------- --------- ---------
Net income available to common stockholders $ 10,958 $(273,721) $ 19,181 $(244,206)
========= ========= ========= =========
NET INCOME (LOSS) PER COMMON SHARE:
Basic $ 0.19 $ (4.47) $ 0.32 $ (4.04)
Diluted 0.19 (4.47) 0.32 (4.04)
CASH DIVIDENDS PAID PER SHARE:
Common $ 0.140 $ 0.500 $ 0.140 $ 1.000
Series A Preferred 0.400 0.400 0.800 0.800
Series B Preferred 0.315 0.315 0.630 0.630
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Six Months Ended
June 30
----------------------------
1999 1998
----------- -----------
OPERATING ACTIVITIES:
Net income (loss) $ 30,590 $ (233,062)
Noncash items:
Amortization of mortgage servicing rights and related costs -- 87,408
Amortization of discount and premium 23,177 90,151
Depreciation and other amortization 531 3,099
(Gain) loss on sale of mortgage assets and derivative financial instruments (1,738) 243,399
Net change in prepaids, receivables, other assets,
accounts payable and accrued expenses (16,983) (12,085)
----------- -----------
Net cash provided (used) by operating activities 35,577 178,910
----------- -----------
INVESTING ACTIVITIES:
Purchases of mortgage securities and other investments (3,937,696) (3,314,151)
Purchases of CMO collateral and investments -- (758,615)
Purchases of mortgage servicing rights -- (56,178)
Purchases of derivative financial instruments -- (54,250)
Principal collections on mortgage investments 677,723 1,303,124
Proceeds from sales of mortgage assets 114,763 3,195,240
Proceeds from sales and settlement of derivative financial instruments 12,595 86,239
CMO collateral:
Principal collections 747,542 502,182
Decrease in accrued interest receivable 5,790 3,945
Decrease (increase) in short-term investments 13,171 (3,481)
----------- -----------
Net cash provided (used) by investing activities (2,366,112) 904,055
----------- -----------
FINANCING ACTIVITIES:
Increase (decrease) in short-term borrowings 3,205,740 (1,111,313)
Increase in mortgage servicing acquisitions payable -- 11,912
Collateralized mortgage obligations:
Issuance of securities -- 597,934
Principal payments on securities (888,747) (562,908)
Decrease in accrued interest payable (5,716) (590)
Capital stock transactions (15,562) 50,261
Dividends paid (19,276) (72,002)
----------- -----------
Net cash provided (used) by financing activities 2,276,439 (1,086,706)
----------- -----------
Net change in cash and cash equivalents (54,096) (3,741)
Cash and cash equivalents at beginning of period 73,385 17,377
----------- -----------
Cash and cash equivalents at end of period $ 19,289 $ 13,636
=========== ===========
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
NOTE 1 -- BUSINESS
Capstead Mortgage Corporation, a mortgage investment firm, earns income from
investing in mortgage assets on a leveraged basis and from other investment
strategies. In response to the lower long-term interest rate environment
experienced in 1998, the Company restructured its mortgage asset portfolios and
sold its mortgage banking operations, which created substantial liquidity.
Currently, the Company's primary focus is managing a portfolio of single-family,
residential mortgage-backed securities issued by government-sponsored entities,
either Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities"). This
portfolio is financed by short-term borrowings and equity. The Company presently
intends to continue to evaluate a number of possibilities to acquire or make
strategic investments in a variety of real estate-related investments and
entities. However, the Company may conclude to continue to substantially limit
its activities to investing in Agency Securities.
NOTE 2 -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the quarter and six months ended June 30,
1999 are not necessarily indicative of the results that may be expected for the
calendar year ending December 31, 1999. 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, 1998.
Certain amounts for prior periods have been reclassified to conform to the
current year presentation.
NOTE 3 -- SHARE REPURCHASES AND DECLARATION OF COMMON STOCK DIVIDEND
On February 4, 1999 the Company's Board of Directors authorized the repurchase
of up to 6,000,000 shares of its common stock and up to 2,000,000 shares of its
$1.26 Cumulative Convertible Preferred Stock, Series B (the "Series B Preferred
Stock"). As of June 30, 1999, the Company had repurchased 2,123,200 shares of
common stock at an average price of $5.16 (including transaction costs) and
354,700 shares of the Series B Preferred Stock at an average price of $12.00
(including transaction costs) pursuant to this repurchase program. In December
1998 the Company completed a previously authorized repurchase of 1 million
shares of common stock at an average price of $4.10 per share (including
transaction costs). In early January 85,583 formerly restricted shares of common
stock were repurchased at $4.12 per share from employees in order to assist them
with meeting their federal income tax obligations resulting from the lapsing of
restrictions on stock awards with the December 1998 sale of the mortgage banking
operations. Altogether the Company has repurchased 5.2 percent of its
outstanding shares of common stock and 2.1 percent of the Series B Preferred
Stock since the first share repurchases in December 1998. All such repurchased
shares have been canceled and returned to authorized but unissued shares.
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On July 23, 1999 the Board of Directors declared a second quarter dividend of 18
cents per common share, payable August 20 to stockholders of record as of August
3, 1999.
NOTE 4 -- MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities investments and the related average effective interest rates
(calculated for the quarter then ended including mortgage insurance costs on
non-agency securities and excluding unrealized gains and losses) were as follows
(dollars in thousands):
Purchase Average
Principal Premiums Carrying Average Effective
Balance (Discounts) Basis Amount Coupon Rate
----------- ----------- ----------- ----------- ------- ---------
* ** **
JUNE 30, 1999
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 1,094,442 $ (3,189) $ 1,091,253 $ 1,062,303 6.17% 6.20%
Medium-term 1,205,019 6,399 1,211,418 1,200,467 6.16 5.82
Adjustable-rate ("ARMs"):
LIBOR/CMT 917,287 21,266 938,553 941,772 7.07 5.23
COFI 266,110 1,724 267,834 261,786 5.80 5.63
GNMA ARMs 1,945,594 30,326 1,975,920 1,977,846 6.38 5.46
----------- ----------- ----------- -----------
5,428,452 56,526 5,484,978 5,444,174 6.39 5.65
Non-agency securities 138,679 346 139,025 139,596 8.36 7.95
----------- ----------- ----------- -----------
$ 5,567,131 $ 56,872 $ 5,624,003 $ 5,583,770 6.44 5.70
=========== =========== =========== ===========
DECEMBER 31, 1998
Agency and U.S. Treasury
Securities:
U.S. Treasury notes $ -- $ -- $ -- $ -- -% 4.68%
FNMA/FHLMC:
Fixed-rate 397,648 (731) 396,917 400,345 6.50 6.42
Medium-term 313,947 3,597 317,544 318,033 6.60 5.67
LIBOR/CMT ARMs 616,274 16,350 632,624 626,356 7.49 5.24
GNMA ARMs 871,308 14,635 885,943 883,451 6.75 5.76
----------- ----------- ----------- -----------
2,199,177 33,851 2,233,028 2,228,185 6.89 5.72
Non-agency securities 140,718 (157) 140,561 141,417 7.22 7.23
----------- ----------- ----------- -----------
$ 2,339,895 $ 33,694 $ 2,373,589 $ 2,369,602 6.91 5.81
=========== =========== =========== ===========
* Includes mark-to-market for securities classified as
available-for-sale, if applicable (see NOTE 7).
** Average Coupon is calculated as of the indicated balance sheet date.
Average Effective Rate is calculated for the quarter then ended.
The Company classifies its mortgage securities by interest rate characteristics
of the underlying single-family residential mortgage loans. Fixed-rate mortgage
securities either (i) have fixed rates of interest for their entire terms, (ii)
have an initial fixed-rate period of 10 years after origination and then adjust
annually based on a specified margin over 1-year U.S. Treasury Securities
("1-year Treasuries"), or (iii) were previously classified as medium-term and
have adjusted to a fixed rate for the remainder of their terms. Medium-term
mortgage securities either (i) have an initial fixed-rate period of 3 or 5 years
after origination and then adjust annually based on a specified margin over
1-year Treasuries, (ii) have initial interest rates that adjust one time,
approximately 5 years following origination of the mortgage loan, based on a
specified margin over Fannie Mae yields for 30-year, fixed-rate commitments at
the time of adjustment, or (iii) fixed-rate mortgage securities that have
expected weighted average lives of 5 years or
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less. Adjustable-rate mortgage securities either (i) adjust semiannually based
on a specified margin over the 6-month London Interbank Offered Rate ("LIBOR"),
(ii) adjust annually based on a specified margin over 1-year Treasuries ("CMT"),
(iii) adjust monthly based on a specific margin over the Cost of Funds Index as
published by the Eleventh District Federal Reserve Bank ("COFI"), or (iv) were
previously classified as medium-term and have begun adjusting annually based on
a specified margin over 1-year Treasuries.
Agency and U.S. Treasury securities consist of Agency Securities and U.S.
government-issued fixed-rate securities, commonly referred to as U.S. Treasury
notes or bonds (collectively, "Agency and U.S. Treasury Securities"). Agency
Securities have no foreclosure risk. Non-agency securities consist of private
mortgage pass-through securities backed primarily by single-family jumbo-sized
residential mortgage loans whereby the related credit risk of the underlying
loans is borne by AAA-rated private mortgage insurers, and other AAA-rated
private mortgage securities (together, "Non-agency Securities"). At December 31,
1998 Non-Agency Securities also included mortgage loans held for sale in
connection with curtailed mortgage production activities. The maturity of
mortgage-backed securities is directly affected by the rate of principal
prepayments on the underlying loans.
NOTE 5 -- CMO COLLATERAL AND INVESTMENTS
Collateralized mortgage obligation ("CMO") collateral consists of (i)
fixed-rate, medium-term and adjustable-rate mortgage securities collateralized
by single-family residential mortgage loans and (ii) related short-term
investments, both pledged to secure CMO borrowings ("Pledged CMO Collateral").
CMO investments have included investments in interest-only mortgage securities
and investments in other CMO securities such as principal-only mortgage
securities. Interest-only mortgage securities are entitled to receive 100
percent of coupon interest stripped from pools of mortgage loans. The components
of CMO collateral and investments are summarized as follows (in thousands):
June 30, 1999 December 31, 1998
------------- -----------------
Pledged CMO Collateral:
Pledged mortgage securities $3,631,862 $4,507,337
Short-term investments 1,708 14,879
Accrued interest receivable 21,571 27,361
---------- ----------
3,655,141 4,549,577
Unamortized premium 12,289 11,830
---------- ----------
3,667,430 4,561,407
CMO investments 3,233 9,867
---------- ----------
$3,670,663 $4,571,274
========== ==========
All principal and interest on pledged mortgage securities is remitted directly
to a collection account maintained by a trustee. The trustee is responsible for
reinvesting those funds in short-term investments. All collections on the
pledged mortgage securities and the reinvestment income earned thereon are
available for the payment of principal and interest on CMO borrowings. Pledged
mortgage securities are private mortgage pass-through securities whereby the
related credit risk of the underlying loans is borne by AAA-rated private
mortgage insurers or subordinated bonds within the related CMO series to which
the collateral is pledged. The Company has retained only $1.1 million of credit
risk in the form of subordinated bonds associated with these securities. The
weighted average effective interest rate for total Pledged CMO Collateral was
7.13 percent during the quarter ended June 30, 1999.
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NOTE 6 -- COLLATERALIZED MORTGAGE OBLIGATIONS
Each series of CMOs issued consists of various classes of bonds, most of which
have fixed rates of interest. Interest is payable monthly or quarterly at
specified rates for all classes. Typically, principal payments on each series
are made to each class in the order of their stated maturities so that no
payment of principal will be made on any class of bonds until all classes having
an earlier stated maturity have been paid in full. The components of CMOs along
with selected other information are summarized as follows (dollars in
thousands):
June 30, 1999 December 31, 1998
------------- -----------------
CMOs $ 3,628,825 $ 4,513,522
Accrued interest payable 19,893 25,609
----------- -----------
Total obligation 3,648,718 4,539,131
Unamortized discount (12,698) (17,807)
----------- -----------
$ 3,636,020 $ 4,521,324
=========== ===========
Range of average interest rates 5.27% to 9.45% 5.22% to 9.45%
Range of stated maturities 2008 to 2028 2007 to 2028
Number of series 25 31
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 7.16 percent during the quarter ended June 30, 1999.
NOTE 7 -- 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 (excluding mortgage
loans held for sale) and CMO investments were estimated using either (i) quoted
market prices when available, including quotes made by lenders in connection
with designating collateral for repurchase arrangements, or (ii) offer prices
for similar assets or market positions. The fair value of Pledged CMO Collateral
was based on projected cash flows, after payment on the related CMOs, determined
using market discount rates and prepayment assumptions. The maturity of mortgage
assets is directly affected by the rate of principal payments on the underlying
mortgage loans and, for Pledged CMO Collateral, Clean-up Calls of the remaining
CMOs outstanding.
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The following table summarizes fair value disclosures for available-for-sale
debt securities (in thousands):
Gross Gross
Unrealized Unrealized Fair
Basis Gains Losses Value
---------- ---------- ---------- ----------
AS OF JUNE 30, 1999
Agency Securities:
FNMA/FHLMC:
Fixed-rate $1,091,253 $ -- $ 28,950 $1,062,303
Medium-term 1,211,418 243 11,194 1,200,467
ARMs:
LIBOR/CMT 938,553 5,511 2,292 941,772
COFI 267,834 -- 6,048 261,786
GNMA ARMs 1,975,920 5,441 3,515 1,977,846
---------- ---------- ---------- ----------
5,484,978 11,195 51,999 5,444,174
Non-agency securities 37,272 571 -- 37,843
CMO collateral and investments 131,938 1,837 133 133,642
---------- ---------- ---------- ----------
$5,654,188 $ 13,603 $ 52,132 $5,615,659
========== ========== ========== ==========
AS OF DECEMBER 31, 1998
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 396,917 $ 3,466 $ 38 $ 400,345
Medium-term 317,544 862 373 318,033
LIBOR/CMT ARMs 632,624 667 6,935 626,356
GNMA ARMs 885,943 819 3,311 883,451
---------- ---------- ---------- ----------
2,233,028 5,814 10,657 2,228,185
Non-agency securities 34,815 856 -- 35,671
CMO collateral and investments 190,916 2,927 158 193,685
---------- ---------- ---------- ----------
$2,458,759 $ 9,597 $ 10,815 $2,457,541
========== ========== ========== ==========
With substantial liquidity as of June 30, 1999, the Company currently has the
ability to hold mortgage assets for the foreseeable future and, therefore, does
not currently expect to realize losses on security sales. Liquidity is defined
as surplus capital available for the support and acquisition of mortgage assets
and other investments or activities.
Held-to-maturity debt securities consist of Pledged CMO Collateral and
collateral released from the related CMO indentures pursuant to Clean-up Calls
and held as Non-agency Securities. The following table summarizes fair value
disclosures for debt securities held-to-maturity (in thousands):
Gross Gross
Unrealized Unrealized Fair
Basis Gains Losses Value
---------- ---------- ---------- ----------
AS OF JUNE 30, 1999
Non-agency Securities $ 101,753 $ 2,218 $ -- $ 103,971
Pledged CMO Collateral 3,537,021 2,526 20,946 3,518,601
---------- ---------- ---------- ----------
$3,638,774 $ 4,744 $ 20,946 $3,622,572
========== ========== ========== ==========
AS OF DECEMBER 31, 1998
Pledged CMO Collateral $4,377,589 $ 3,286 $ 26,359 $4,354,516
========== ========== ========== ==========
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Sales of released CMO collateral occasionally occur provided the collateral has
paid down to within 15 percent of its original issuance amounts. The following
table summarizes disclosures related to dispositions of debt securities (in
thousands):
Quarter Ended June 30 Six Months Ended June 30
----------------------- ---------------------------
1999 1998 1999 1998
------ ---------- ------- -------------
Sale of securities held available-for-sale:
Amortized cost $ -- $ 2,586,480 $ 7,573 $ 3,237,953
Gains (losses)* -- (253,315) 1,761 (248,594)
Sale of released CMO collateral held-to-maturity:
Amortized cost -- -- -- 5,022
Gains -- -- -- 471
* Excludes a first quarter 1999 loss of $23,000 on disposition of remaining
derivative financial instruments held by the Company.
NOTE 8 -- COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is net income (loss) plus other comprehensive income
(loss), which, for the periods presented, consists of the change in unrealized
gain (loss) on debt securities classified as available-for-sale. The following
table provides information regarding comprehensive income (loss) for the periods
indicated (in thousands):
Quarter Ended Six Months Ended
June 30 June 30
------------------------ ------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
Net income (loss) $ 16,683 $(268,132) $ 30,590 $(233,062)
--------- --------- --------- ---------
Other comprehensive income (loss):
Unrealized gain (loss) on debt securities:
Change in unrealized gain (loss) during period (48,096) (124,440) (35,550) (180,210)
Reclassification adjustment for (gain)
loss included in net income (loss) -- 253,315 (1,761) 248,594
--------- --------- --------- ---------
Other comprehensive income (48,096) 128,875 (37,311) 68,384
--------- --------- --------- ---------
Comprehensive income (loss) $ (31,413) $(139,257) $ (6,721) $(164,678)
========= ========= ========= =========
NOTE 9 -- NET INTEREST INCOME ANALYSIS
The following tables summarize interest income and interest expense and average
effective interest rates for the periods indicated (dollars in thousands):
Quarter Ended June 30
---------------------------------------------------------
1999 1998
--------------------------- ---------------------------
Amount Average Amount Average
-------- --------- -------- ---------
Interest income:
Mortgage securities and other investments $ 78,150 5.70% $104,213 5.98%
CMO collateral and investments 68,041 7.12 97,658 7.46
-------- --------
Total interest income 146,191 201,871
-------- --------
Interest expense:
Short-term borrowings 60,327 4.87 106,426 5.53
CMOs 67,915 7.16 83,950 7.66
-------- --------
Total interest expense 128,242 190,376
-------- --------
Net interest $ 17,949 $ 11,495
======== ========
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Six Months Ended June 30
-------------------------------------------------------
1999 1998
------------------------ -----------------------
Amount Average Amount Average
---------- ---------- ---------- ----------
Interest income:
Mortgage securities and other investments $125,462 5.74% $202,997 6.07%
CMO collateral and investments 145,071 7.15 191,893 7.37
------- -------
Total interest income 270,533 394,890
------- -------
Interest expense:
Short-term borrowings 94,241 4.90 206,162 5.58
CMOs 145,432 7.23 161,753 7.53
------- -------
Total interest expense 239,673 367,915
------- -------
Net interest $30,860 $26,975
======= =======
The following tables summarize increases (decreases) in interest income and
interest expense due to changes in interest rates versus changes in volume for
the quarter and six months ended June 30, 1999 compared to the same periods in
1998 (in thousands):
Quarter Ended June 30, 1999
------------------------------------
Rate* Volume* Total
-------- -------- --------
Interest income:
Mortgage securities and other investments $ (4,529) $(21,534) $(26,063)
CMO collateral and investments (4,241) (25,376) (29,617)
-------- -------- --------
Total interest income (8,770) (46,910) (55,680)
-------- -------- --------
Interest expense:
Short-term borrowings (11,678) (34,421) (46,099)
CMOs (5,181) (10,854) (16,035)
-------- -------- --------
Total interest expense (16,859) (45,275) (62,134)
-------- -------- --------
Net interest $ 8,089 $ (1,635) $ 6,454
======== ======== ========
Six Months Ended June 30, 1999
---------------------------------------
Rate* Volume* Total
--------- --------- ---------
Interest income:
Mortgage securities and other investments $ (10,670) $ (66,865) $ (77,535)
CMO collateral and investments (5,431) (41,391) (46,822)
--------- --------- ---------
Total interest income (16,101) (108,256) (124,357)
--------- --------- ---------
Interest expense:
Short-term borrowings (22,860) (89,061) (111,921)
CMOs (6,306) (10,015) (16,321)
--------- --------- ---------
Total interest expense (29,166) (99,076) (128,242)
--------- --------- ---------
Net interest $ 13,065 $ (9,180) $ 3,885
========= ========= =========
* 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.
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NOTE 10 -- STOCKHOLDER LITIGATION
During 1998 twenty-four purported class action lawsuits were filed against the
Company and certain of its officers alleging, among other things, that the
defendants violated federal securities laws by publicly issuing false and
misleading statements and omitting disclosure of material adverse information
regarding the Company's business during various periods between January 28, 1997
and July 24, 1998. The complaints claim that as a result of such alleged
improper actions, the market prices of the Company's equity securities were
artificially inflated during that time period. The complaints seek monetary
damages in an undetermined amount. In March 1999 these actions were
consolidated. The date by which the Company is to respond has not yet run. The
Company believes it has meritorious defenses to the claims and intends to
vigorously defend the actions. Based on available information, management
believes the resolution of these suits will not have a material adverse effect
on the financial position of the Company.
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14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
OVERVIEW
Capstead Mortgage Corporation, a mortgage investment firm, earns income from
investing in mortgage assets on a leveraged basis and from other investment
strategies. In response to the lower long-term interest rate environment
experienced in 1998, the Company restructured its mortgage asset portfolios and
sold its mortgage banking operations, which substantially increased the
Company's liquidity. Currently, the Company's primary focus is managing a
portfolio of single-family residential mortgage-backed securities issued by
government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae
("Agency Securities"). This portfolio is financed by short-term borrowings and
equity. After acquiring $3.3 billion of Agency Securities during the first
quarter of 1999, the Company increased its portfolio of Agency Securities only
modestly during the second quarter to $5.4 billion as of June 30, 1999. In the
third quarter, the Company currently expects to continue to maintain its Agency
Securities portfolio at approximately the same level. The Company's leverage
ratio (short-term borrowings to stockholders' equity, before other comprehensive
income adjustments) increased from 2.7:1 at year-end to 7.5:1 at June 30, 1999.
During 1999 prepayments of mortgage loans underlying the Company's mortgage
assets have declined considerably because of higher mortgage interest rates.
Lower prepayment levels improve yields on the Company's mortgage assets by
allowing related purchase premiums to be expensed to earnings over a longer
period of time. The Company currently expects prepayments to decline further in
the third quarter. In addition, the yields on adjustable-rate ("ARM") mortgage
securities, which represented approximately 57 percent of the Company's mortgage
investment portfolios as of June 30, 1999, should improve over the next 12
months as interest rates on mortgage loans underlying these securities reset to
levels more reflective of the current interest rate environment.
The Company's borrowing rates have been over one-half of one percentage point
lower during 1999 than in the comparable period of 1998. However, the Federal
Reserve increased short-term interest rates by one-quarter of one percent at its
June 29, 1999 meeting and may increase rates further, perhaps in the third
quarter. If short-term borrowing rates were to continue to rise, improving
mortgage asset yields over the next 12 months would not fully keep pace and net
interest margins would decline.
As of June 30, 1999, the Company had repurchased 5.2 percent of its outstanding
shares of common stock and 2.1 percent of its $1.26 Cumulative Convertible
Preferred Stock, Series B (the "Series B Preferred Stock") since share
repurchases began in December 1998. As the common stock continues to sell below
its book value, such repurchases may continue. Acquiring common stock at prices
below book value per share results in modest increases in book value per share
and net income per share.
Liquidity, which is defined as surplus capital available for the support and
acquisition of mortgage assets and other investments or activities, fluctuates
with, among other things, the size and fair value of the Company's mortgage
investment portfolios. Since year-end, stock repurchases, acquisitions of
mortgage assets and a decline in fair value of the Company's portfolios as a
result of higher interest rates in the second quarter have led to a decline in
the Company's liquidity. However, liquidity at quarter-end remains substantial
affording the Company the ability to maintain its mortgage asset portfolios at
current levels for the foreseeable future and to make additional investments.
The Company presently intends to continue to evaluate a number of possibilities
to acquire or make strategic investments in a
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variety of real estate-related investments and entities. However, the Company
may conclude to substantially limit its activities to investing in Agency
Securities.
MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities and other investments consist primarily of high quality
single-family residential mortgage-backed securities, most of which are Agency
Securities. Agency Securities have no foreclosure risk; however, the Company is
subject to reduced net interest margins during periods of rising short-term
interest rates or increasing prepayment rates (see "Effects of Interest Rate
Changes"). The Company may also invest in government-issued securities, commonly
referred to as U.S. Treasury notes or bonds. 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 classifies its mortgage securities and other investments by interest
rate characteristics of the underlying loans or the securities themselves (see
NOTE 4 to the accompanying consolidated financial statements). Mortgage
securities and other investments are financed under repurchase arrangements with
investment banking firms pursuant to which specific securities held within the
portfolios are pledged as collateral (see "Liquidity and Capital Resources").
The following yield and cost analysis illustrates results achieved during the
most recent quarter for each component of the Company's mortgage investment
portfolio and its currently projected earnings capacity based on current
lifetime prepayment assumptions and recent borrowing rates:**
Average for the Quarter Ended
June 30, 1999 As of June 30, 1999
------------------------------------ ------------------------------
Purchase Lifetime
Actual Actual Premiums Projected Prepayment
Mortgage Investments Basis Yield/Cos Runoff (Discounts) Basis Yield/Cost Assumptions
- ----------------------- ----------- --------- ------- ----------- ---------- ---------- -----------
* * ** **
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 1,097,411 6.20% 6% $ (3,189) $ 1,091,253 6.20% 8%
Medium-term 1,006,625 5.82 22 6,399 1,211,418 5.84 20
ARMs:
LIBOR/CMT 944,576 5.23 36 21,266 938,553 5.49 40
COFI 268,332 5.63 16 1,724 267,834 5.51 18
GNMA ARMs 2,024,913 5.46 29 30,326 1,975,920 5.62 27
----------- ---- ----------- ----------- ----------- ---- -----------
5,341,857 5.65 24 56,526 5,484,978 5.76 23
Non-agency Securities 131,360 7.95 47 346 139,025 7.93 50
----------- ---- ----------- ----------- ----------- ---- -----------
5,473,217 5.70 25% $ 56,872 5,624,003 5.81 24%
=========== =========== ===========
Less short-term
borrowings 4,907,053 4.87 5,045,608 5.09
----------- ---- ----------- ----
Capital employed/
financing spread $ 566,164 0.83% $ 578,395 0.72%
=========== ==== =========== ====
Return on assets*** 1.29% 1.24%
* Basis is the Company's investment before mark to market.
** Projected yields are computed based on the Company's current lifetime
prepayment assumptions. Actual yields realized in future periods will
depend upon actual prepayments and any changes in lifetime prepayment
assumptions. For example, if actual prepayments are lower than current
lifetime prepayment assumptions, actual yields will typically be
higher. Projected borrowing rates reflect increases in short-term
interest rates experienced by the Company in July 1999. Actual
borrowing rates will be largely dependent upon the outlook for future
actions by the Federal Reserve to change short-term interest rates.
*** The Company uses its liquidity to pay down short-term indebtedness.
Return on assets is calculated assuming the use of this liquidity to
reduce borrowing costs.
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16
The Company acquired $730 million of fixed-rate, $994 million of medium-term,
$802 million of Fannie Mae/Freddie Mac ARM and $1.4 billion of Ginnie Mae ARM
Agency Securities during the six months ended June 30, 1999, increasing its
portfolio of Agency Securities to $5.4 billion at June 30, 1999 from $2.2
billion at December 31, 1998 (all but $598 million of these securities were
acquired in the first quarter of 1999). The Company currently expects to
continue to maintain this portfolio at this level in the third quarter. The
Company also called for redemption six series of collateralized mortgage
obligations in 1999 returning $142 million of fixed and adjustable-rate mortgage
loans to its Non-agency Securities portfolio. Investments in fixed-rate mortgage
securities, although higher in dollar terms, were slightly lower as a percentage
of total mortgage investments (21.3 percent at June 30, 1999 compared to 22.9
percent at December 31, 1998). Medium-term mortgage securities increased to 21.5
percent at June 30, 1999 compared to 13.4 percent at December 31, 1998, while
ARM investments declined to 57.2 percent at quarter-end from 63.7 percent at
year-end. The Company's leverage ratio increased to 7.5:1 at June 30, 1999 from
2.7:1 at December 31, 1998.
The unamortized net premium paid for these portfolios (referred to as "purchase
premiums (discounts)") increased to $56.9 million at June 30, 1999 from $33.7
million at December 31, 1998, while actually declining as a percentage of
related unpaid principal balances to 1.02 percent from 1.44 percent at year-end.
Purchase premiums (discounts) are amortized to income as yield adjustments based
on both actual prepayments and lifetime prepayment assumptions. Actual
prepayments have declined throughout 1999 as mortgage interest rates increased.
Prepayments on Fannie Mae and Freddie Mac medium-term and adjustable-rate Agency
Securities declined to an annualized rate of 24.9 percent in June 1999 from 48.4
percent in December 1998. Prepayments on Ginnie Mae ARMs declined to an
annualized rate of 27.1 percent in June 1999, from 37.9 percent in December
1998. The Company currently expects prepayments to decline further in the third
quarter. In addition, yields on ARM securities should improve over the next 12
months as interest rates on mortgage loans underlying these securities reset to
levels more reflective of the current interest rate environment (see "Effects of
Interest Rate Changes").
CMO COLLATERAL AND INVESTMENTS
The Company had been an active issuer of CMOs and other securities backed by
single-family jumbo-sized residential mortgage loans obtained through a mortgage
loan conduit business that the Company exited in 1995. Since then, the Company
has maintained finance subsidiaries with remaining capacity to issue CMOs and
other securitizations ("securitization shelves"). In an effort to recover costs
associated with these securitization shelves, and to potentially add to its CMO
administration activities, the Company from time to time purchases mortgage
loans from originators or conduits and issues CMOs or other securities backed by
these loans. The Company may or may not retain a significant residual economic
interest in these securitizations. In 1997 and 1998, the Company issued four
such CMOs totaling $2.2 billion. Also in 1998, in order to enhance its
liquidity, the Company issued a $345 million CMO backed by Non-agency
Securities. No CMOs have been issued in 1999.
The related credit risk of the mortgage loans collateralizing CMOs issued by the
Company is borne by AAA-rated private mortgage insurers or by subordinated bonds
within the related CMO series to which the collateral is pledged. The Company
has retained only $1.1 million of credit risk in the form of subordinated bonds
associated with these securities. The Company also retained residual interests
in certain of these securitizations primarily with the characteristics of
interest-only mortgage securities. Interest-only mortgage securities are
entitled to receive all or some portion of the interest stripped from the
mortgage loans underlying the securities. In lieu of issuing CMOs, the Company
had increased its CMO investments (defined as CMO collateral and investments,
net of related bonds) by acquiring interest-only mortgage securities issued by
other issuers, primarily Fannie Mae and Freddie Mac. In the second quarter of
1998 the Company disposed of a $1.0 billion interest-only mortgage securities
portfolio
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at a substantial loss and during the first quarter of 1999 sold its remaining
purchased interest-only mortgage securities.
As of June 30, 1999, the Company's CMO investments had been reduced to $34.6
million, down from $50.0 million at December 31, 1998. Included in this net
investment are $12.3 million and $12.7 million of the remaining CMO collateral
premiums and bond discounts, respectively. Similar to purchase premiums on the
Company's mortgage investments, CMO collateral premiums and bond discounts,
along with most of remaining CMO investments, are amortized to income as CMO
collateral yield or bond expense adjustments based on both actual prepayments
and lifetime prepayment assumptions (see "Effects of Interest Rate Changes").
UTILIZATION OF CAPITAL AND LIQUIDITY
The following table summarizes the Company's utilization of capital and
liquidity as of June 30, 1999 (in thousands):
Capital
Assets Borrowings Employed Liquidity
----------- ----------- ---------- -----------
*
Agency Securities:
FNMA/FHLMC:
Fixed-rate $1,062,303 $1,031,840 $ 30,463 $ 6,614
Medium-term 1,200,467 1,137,561 62,906 26,757
ARMs:
LIBOR/CMT 941,772 895,346 46,426 18,207
COFI 261,786 256,649 5,137 (2,815)
GNMA ARMs 1,977,846 1,724,212 253,634 194,708
----------- ----------- --------- ---------
5,444,174 5,045,608 398,566 243,471
Non-agency Securities 139,596 - 139,596 136,142
CMO collateral and investments 3,670,663 3,636,020 34,643 7,241
----------- ----------- ---------- -----------
$9,254,433 $8,681,628 572,805 386,854
========== ==========
Other assets, net of other liabilities 65,837 19,289**
---------- ----------
$638,642 $406,143
======== ========
* Based on additional borrowings available under existing uncommitted
repurchase arrangements considering the size and fair values of the
Company's mortgage asset portfolios as of June 30, 1999 (see "Liquidity
and Capital Resources").
** Represents unrestricted cash and cash equivalents.
STOCK REPURCHASES AND BOOK VALUES PER COMMON SHARE
On February 4, 1999 the Company's Board of Directors authorized the repurchase
of up to an additional 6 million shares of its common stock and up to 2 million
shares of its Series B Preferred Stock. As of June 30, 1999, the Company had
repurchased 2,123,200 shares of common stock at an average price of $5.16
(including transaction costs) and 354,700 shares of the Series B Preferred Stock
at an average price of $12.00 (including transaction costs) pursuant to this
repurchase program. In December 1998 the Company completed a previously
authorized repurchase of 1 million shares of common stock at an average price of
$4.10 per share (including transaction costs). In early January, 85,583 formerly
restricted shares of common stock were repurchased at $4.12 per share from
employees in order to assist them with meeting their federal income tax
obligations resulting from the lapsing of restrictions on stock awards with the
December 1998 sale of the mortgage banking operations.
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Since the first share repurchases in December 1998, the Company has repurchased
5.2 percent of its outstanding shares of common stock and 2.1 percent of its
outstanding shares of the Series B Preferred Stock. As the common stock
continues to sell below its book value per share, share repurchases may
continue. Acquiring common stock at prices below book value per share results in
modest increases in book value per share and net income per share. The Company
ended the quarter with 58,339,000 common shares outstanding. Book values per
common share outstanding at the respective balance sheet dates were as follows:
June 30, 1999 December 31, 1998
------------- -----------------
Calculated assuming liquidation of preferred stock* $7.54 $7.88
Calculated assuming redemption of preferred stock** 7.21 7.56
* The Series A and B Preferred Stock have liquidation preferences of
$16.40 and $11.38 per share, respectively.
** The Series A and B Preferred Stock have redemption prices of $16.40 and
$12.50 per share, respectively.
Of the 35 cent decline in book value per common share during the six months
ended June 30, 1999 (calculated assuming redemption of the Company's convertible
preferred stock), 64 cents was attributable primarily to a reduction in the
value of Agency Securities held available-for-sale because of a one-half of one
percentage point increase in intermediate and long-term interest rates during
the second quarter. This decline was partially offset by a 19 cent increase in
undistributed income and a 10 cent increase due to the repurchase of common
shares. Note that subsequent to quarter-end, the Company declared a 18 cent per
common share second quarter dividend payable August 20 to stockholders of record
on August 3, 1999.
RESULTS OF OPERATIONS
Comparative net operating results (interest income or fee revenues, net of
related interest expense and, for CMO administration and the curtailed mortgage
banking operations, related direct and indirect operating expenses) by source
were as follows (in thousands, except per share amounts):
Quarter Ended Six Months Ended
June 30 June 30
------------------------ ------------------------
1999 1998 1999 1998
-------- ---------- ------- ----------
Agency and U.S. Treasury Securities $15,100 $ 6,945 $26,917 $ 15,082
Non-agency Securities 2,612 1,448 4,141 3,255
CMO collateral and investments (285) 2,120 (1,347) 6,544
--------- ------------- --------- -------------
Net margin on mortgage assets and
other investments 17,427 10,513 29,711 24,881
Mortgage banking operations - (27,153) - (12,308)
Other operating revenue (expense):
Gain (loss) on sale of mortgage assets and
derivative financial instruments - (251,207) 1,738 (244,444)
CMO administration and other 903 1,066 2,373 2,001
Other operating expenses (1,647) (1,351) (3,232) (3,192)
--------- ------------ --------- ------------
Net income (loss) $16,683 $(268,132) $30,590 $(233,062)
======= ========= ======= =========
Net income (loss) per common share:
Basic $0.19 $(4.47) $0.32 $(4.04)
Diluted 0.19 (4.47) 0.32 (4.04)
Operating results for the quarter and six months ended June 30, 1999 were
substantially improved over 1998 results which included impairment charges on
mortgage servicing and losses realized from
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restructuring the Company's mortgage asset portfolios. Liquidity from this
restructuring and from the December 1998 sale of the mortgage banking operations
has been deployed to reduce short-term borrowings which has benefited net
margins on the Company's mortgage asset portfolios. Margins also benefited from
first quarter 1999 acquisitions of Agency Securities, slower prepayments and
lower borrowing rates.
The earning capacity of the Company's mortgage asset portfolios are largely
dependent on the extent to which the Company continues to invest its liquidity
in these portfolios, the overall size of the portfolios and the relationship
between short- and long-term interest rates (the "yield curve"). The Company
presently intends to continue to evaluate a number of possibilities to redeploy
some portion of its liquidity into strategic investments in a variety of real
estate-related investments and entities. However, the Company may conclude to
continue to substantially limit its activities to investing in Agency
Securities. In the third quarter of 1999, the Company currently expects to
maintain its Agency Securities portfolio at approximately the same level as in
the second quarter. The effects on borrowing rates as a result of the Federal
Reserve increasing short-term interest rates by one-quarter of one percentage
point at its June 29, 1999 meeting are expected to be substantially offset by
the benefits of lower prepayments. However, if short-term borrowing rates were
to continue to rise, improving mortgage asset yields over the next 12 months
would not fully keep pace and net interest margins would decline. Although
Agency Securities have no foreclosure risk, the Company is subject to reduced
interest margins during periods of rising short-term interest rates or
increasing prepayment rates. As a result, there can be no assurance of
increasing or even stable earnings and common dividends (see "Effects of
Interest Rate Changes").
Agency and U.S. Treasury Securities contributed more to operating results during
the quarter and six months ended June 30, 1999 than during the same periods in
1998 despite a lower average outstanding portfolio due primarily to lower
borrowings secured by this portfolio and, to a lesser extent, due to a
significant improvement in financing spreads. On average, the Company employed
$437 million and $446 million of its capital to the Agency Securities portfolio
during the quarter and six months ended June 30, 1999, respectively, compared to
only $135 million and $127 million during the same periods in 1998. The average
outstanding portfolio of $5.3 billion during the current quarter was 16 percent
lower than during the same period in 1998. Yields for this portfolio were 5.65
percent and 5.67 percent during the quarter and six months ended June 30, 1999,
respectively, compared to 5.88 percent and 5.97 percent during the same periods
in 1998, while average borrowing rates were 4.87 percent and 4.90 percent,
respectively, compared to 5.51 percent and 5.56 percent during the same periods
in 1998. Lower yields reflect (i) changes in portfolio mix (ii) lower 6-month
London Interbank Offered Rate ("LIBOR") and 1-year U.S. Treasury rates
experienced during much of 1998 which contributed to declining yields on ARM
securities because ARM loans underlying most of the Company's ARM Securities
reset periodically based on those indices and (iii) relatively high lifetime
prepayment assumptions currently being used to amortize purchase premiums. For
further discussion on investment yields, see "Financial Condition - Mortgage
Securities and Other Investments" and "Effects of Interest Rate Changes".
Non-agency Securities contributed more to operating results during the quarter
and six months ended June 30, 1999 despite a lower average outstanding portfolio
primarily because the Company funded this portfolio entirely with its equity.
The average outstanding portfolio was $131 million and $107 million during the
quarter and six months ended June 30, 1999, respectively, compared to $643
million and $662 million for the same periods in 1998 during which time only
limited capital was employed supporting this portfolio. Average yields for this
portfolio (calculated including mortgage insurance costs) were 7.95 percent and
7.99 percent during the quarter and six months ended June 30, 1999,
respectively, compared to 6.74 percent and 6.78 percent during the same periods
in 1998.
CMO collateral and investments contributed substantially less to operating
results during the quarter and six months ended June 30, 1999 than during the
same periods in 1998 primarily because of the disposition
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of a $1.0 billion interest-only mortgage securities portfolio in June 1998,
subsequent sales of remaining purchased interest-only mortgage securities and
redemptions of CMOs, which together have significantly diminished the earning
capacity of this portfolio. Without growth of this portfolio either through the
issuance of CMOs in which the Company retains residual interests, or the
acquisition of other CMO investments, it is likely this portfolio will not
provide a positive return on capital employed in future periods.
The mortgage banking operations were sold in December 1998. At December 31, 1998
the Company had established an accrual of over $23 million for contract
settlement provisions and anticipated costs associated with exiting the mortgage
banking operations. During the six months ended June 30, 1999, the Company
settled approximately $19 million of this liability including a $16 million
prepayment protection settlement payment and over $2 million in pricing
adjustments on mortgage servicing rights acquisition agreements assumed by the
buyer.
Operating expenses during the quarter and six months ended June 30, 1999 were
higher than in the same periods in 1998 primarily because of
restructuring-related adjustments recorded in 1998 lowering compensation-related
accruals. Ongoing operating expenses are expected to be at a similar level as
incurred in the first half of 1999.
The Company did not incur any gains or losses on sales of mortgage assets during
the second quarter of 1999. Gains recorded in the first quarter of 1999 relate
primarily to the sale of remaining purchased interest-only mortgage securities
held as CMO investments. Losses recorded in 1998 reflect sales of interest-only
mortgage securities and other mortgage assets as part of the restructuring of
the Company's mortgage asset portfolios begun in June 1998 in response to
deteriorating conditions in the mortgage finance industry experienced at that
time.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds include short-term borrowings, monthly
principal and interest payments on mortgage securities and other investments,
excess cash flows on CMO investments and proceeds from sales of mortgage assets.
The Company has substantial liquidity with the 1998 restructuring of its
mortgage asset portfolios and the sale of its mortgage banking operations, which
has been deployed to reduce short-term borrowings (see above "Financial
Condition"). The Company currently believes that these funds are sufficient for
the acquisition of mortgage assets, repayments on short-term borrowings, the
payment of cash dividends as required for Capstead's continued qualification as
a Real Estate Investment Trust ("REIT") and common and preferred stock
repurchases as described below. In addition, the liquidity provided by the sale
of the mortgage banking operations affords the Company the opportunity to make
strategic investments in a variety of real estate-related investments and
entities. There can be no assurances, however, that the Company will make any
such investments. It is the Company's policy to remain strongly capitalized and
conservatively leveraged.
Short-term borrowings are primarily made under repurchase arrangements. The
Company has uncommitted repurchase facilities with investment banking firms to
finance mortgage assets, subject to certain conditions. Interest rates on
borrowings under these facilities are based on overnight to 30-day London
Interbank Offered Rate ("LIBOR") rates. The terms and conditions of these
arrangements, including interest rates, are negotiated on a
transaction-by-transaction basis. 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. Because of the credit-worthiness of securities issued by
government-sponsored entities and the U.S. government, the Company has
concentrated its investments financed using repurchase arrangements on these
securities.
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In February 1999 the Company's Board of Directors authorized the repurchase of
up to 6 million shares of common stock and up to 2 million shares of the Series
B Preferred Stock. As of June 30, 1999, 3.9 million and 1.6 million shares of
common and Series B Preferred Stock, respectively, remained available for
repurchase under this program. The Company may continue to repurchase shares in
open market transactions from time to time subject to the price of its
securities and alternative investment opportunities.
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 derivative financial instruments
("Derivatives") held, if any, are included in this analysis. In addition, the
sensitivity of CMO administration fee income to market interest rate levels is
included as well. The model incorporates management assumptions regarding the
level of prepayments on mortgage assets for a given level of market rate changes
using industry estimates of prepayment speeds for various coupon segments. These
assumptions are developed through a combination of historical analysis and
future expected pricing behavior. As of June 30, 1999, the Company had the
following estimated earnings sensitivity profile:
Immediate Change In:
(rates in basis points, dollars in thousands)
-----------------------------------------------------
30-day LIBOR rate Down 100 Down 100 Flat Up 100
10-year U.S. Treasury rate Down 100 Flat Up 100 Up 100
Projected 12-month earnings change* $22,431 $31,146 $8,354 $(31,080)
* Note that the impact of actual or planned acquisitions of mortgage
assets subsequent to quarter-end (beyond acquisitions necessary to
replace runoff) and potential new business activities were not factored
into the simulation model for purposes of this disclosure.
Income simulation modeling is a primary tool used to assess the direction and
magnitude of changes in net margins on mortgage assets resulting from changes in
interest rates. Key assumptions in the model include prepayment rates on
mortgage assets, changes in market conditions, and management's financial
capital plans. These assumptions are inherently uncertain and, as a result, the
model cannot precisely estimate net margins or precisely predict the impact of
higher or lower interest rates on net margins. Actual results will differ from
simulated results due to timing, magnitude and frequency of interest rate
changes and other changes in market conditions, management strategies and other
factors.
GENERAL DISCUSSION OF EFFECTS OF INTEREST RATE CHANGES
Changes in interest rates may impact the Company's earnings in various ways. The
Company's earnings depend, in part, on the difference between the interest
received on mortgage securities and other investments, and the interest paid on
related short-term borrowings. The resulting spread may be reduced or even
eliminated in a rising short-term interest rate environment. Because a
substantial portion of the Company's mortgage investments are ARM mortgage
securities, the risk of rising short-term interest rates is generally offset to
some extent by increases in the rates of interest earned on the underlying ARM
loans, which reset periodically based on underlying indices (generally 6-month
LIBOR and 1-year U.S. Treasury rates). Since ARM loans generally limit the
amount of such increases during any single interest rate adjustment period and
over the life of the loan, interest rates on borrowings can rise to levels that
may exceed the interest rates on the underlying loans contributing to lower or
even negative financing spreads. At other times, as seen in 1998, declines in
these indices may be greater than declines in the Company's
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borrowing rates which are based on 30-day LIBOR, contributing to lower or even
negative financing spreads. The Company may invest in Derivatives from time to
time, specifically interest rate caps, as a hedge against rising interest rates
on a portion of its short-term borrowings. Interest rate caps generally increase
in value as related interest rates rise and decline in value when such rates
fall.
Another effect of changes in interest rates is that, as long-term interest rates
decrease, the rate of prepayment of mortgage loans underlying mortgage
investments generally increases. To the extent the proceeds of prepayments on
mortgage investments cannot be reinvested at a rate of interest at least equal
to the rate previously earned on such investments, earnings may be adversely
affected. As seen in 1998 prolonged periods of high prepayments can
significantly reduce the expected life of mortgage investments; therefore, the
actual yields realized can be lower due to faster amortization of purchase
premiums. In addition, the rates of interest earned on ARM investments generally
will decline during periods of falling short-term interest rates as the
underlying ARM loans reset at lower rates.
Changes in interest rates also impact earnings recognized from CMO investments,
which have consisted primarily of interest-only mortgage securities and
fixed-rate CMO residuals (see above "Financial Condition"). The amount of income
that may be generated from interest-only mortgage securities is dependent upon
the rate of principal prepayments on the underlying mortgage collateral. If
mortgage interest rates fall significantly below interest rates on the
collateral, principal prepayments may increase, reducing or eliminating the
overall return on these investments. As seen in 1998 sustained periods of high
prepayments can result in losses. Conversely, if mortgage interest rates rise,
interest-only mortgage securities tend to perform favorably because underlying
mortgage loans will generally prepay at slower rates, thereby increasing overall
returns. The Company sold its investments interest-only mortgage securities in
connection with the 1998 restructuring of its mortgage asset portfolios.
CMO residuals behave similarly to interest-only mortgage securities. As seen in
1998 if mortgage interest rates fall, prepayments on the underlying mortgage
loans generally will be higher thereby reducing or even eliminating overall
returns on these investments. This is due primarily to the acceleration of the
amortization of bond discounts, a noncash item, as bond classes are repaid more
rapidly than originally anticipated. Conversely, if mortgage interest rates rise
significantly above interest rates on the collateral, principal prepayments will
typically diminish, improving the overall return on an investment in a
fixed-rate CMO residual because of an increase in time over which the Company
receives the larger positive interest spread.
The Company periodically sells mortgage assets. Such sales may become attractive
as values of mortgage assets fluctuate with changes in interest rates. At other
times, such as in 1998, it may become prudent to significantly downsize mortgage
asset portfolios, for example, to mitigate exposure to further declines in
mortgage interest rates. In either case, sales of mortgage assets may increase
income volatility because of the recognition of transactional gains or losses.
With the sale of the interest-only mortgage securities and the mortgage banking
operations, the Company has significantly reduced its exposure to declining
mortgage interest rates and therefore the use of Derivatives to manage this
exposure has been curtailed. As a result, the Company currently does not hold
Derivatives, such as interest rate floors, to help offset the effects of falling
interest rates on the Company's mortgage asset portfolios.
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OTHER
IMPACT OF THE YEAR 2000
Many existing computer software programs use only two digits to identify the
year in date fields and, as such, could fail or create erroneous results by or
at the Year 2000. The Company utilizes a number of software systems to
administer securitizations and manage its mortgage assets. In addition, the
Company utilizes vendors in various capacities and interfaces with various
institutions. The Company is exposed to the risk that its systems and the
systems of its vendors and institutions it interfaces with are not Year 2000
compliant.
State of Readiness. The Company has made and will continue to make investments
in its software systems and applications to ensure the Company is Year 2000
compliant. The Company is also taking steps to ensure that the vendors it
utilizes and institutions that it interfaces with are also taking the necessary
steps to become Year 2000 compliant. This process is expected to be completed in
the third quarter of 1999. In addition, with the sale of the mortgage banking
operations in December 1998, the Company has built a new computer network that
is considered to be Year 2000 compliant.
Costs. The financial costs of becoming Year 2000 compliant for the ongoing
operations of the Company, including the construction of the Company's new
computer network, have not and are not expected to exceed $400,000.
Risks and Contingency Planning. Although the Company expects that all its
systems and applications will be Year 2000 compliant well prior to December 31,
1999, there can be no assurance that all of the vendors it utilizes and
institutions that it interfaces with will complete their compliance efforts. The
Company will continue to monitor their efforts in this regard and is currently
drafting contingency plans for all critical processes to help ensure the impact
on the Company's operations, or that of customers or vendors will be minimized
if an event of non-compliance occurs. These plans include arranging for the use
of other vendors or other methodologies and processes to transact the Company's
business. The effect of any such disruption to the Company's operations is not
presently determinable.
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 as a
result of 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, the effectiveness of risk
management strategies, the impact of leverage, liquidity of credit markets, Year
2000 compliance failures, increases in costs and other general competitive
factors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS
The information required by this Item is incorporated by reference to the
information included in Item 2, "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Stockholders was held on May 27, 1999.
(b) The following Directors were elected to Board of Directors
(constituting the entire Board of Directors):
Bevis Longstreth Harriet E. Miers
Paul M. Low William R. Smith
Ronn K. Lytle John C. Tolleson
(c) The following items were voted on at the Annual Meeting:
VOTES
------------------------------------------------------------
Withheld/ Broker
For Against Abstentions Non-votes
---------- ------- ----------- ---------
Election of Board Members:
Bevis Longstreth...................... 54,169,058 - 1,922,334 -
Paul M. Low........................... 54,265,251 - 1,826,141 -
Ronn K. Lytle......................... 54,199,290 - 1,892,102 -
Harriet E. Miers...................... 54,271,881 - 1,819,511 -
William R. Smith...................... 54,278,897 - 1,812,495 -
John C. Tolleson...................... 54,287,520 - 1,803,872 -
Other matters (no other matters).
PART II. -- OTHER INFORMATION
ITEM 5. OTHER INFORMATION
STOCKHOLDER PROPOSALS FOR 2000 ANNUAL MEETING OF STOCKHOLDERS
Any proposal of stockholders to be included in the Company's proxy statement
relating to the Company's 2000 Annual Meeting of Stockholders pursuant to Rule
14a-8 under the Exchange Act must be received by the Company at its principal
executive offices no later than December 8, 1999; such proposal must also comply
with Rule 14a-8 if the proposal is to be considered for inclusion in the
Company's proxy statement for such meeting. The Company must receive notice of
any stockholder proposal to be brought before the meeting outside the process of
Rule 14a-8 at the Company's principal executive offices not later than January
20, 2000.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The following Exhibits are presented herewith:
Exhibit 11 - Computation of Earnings Per Share for the Quarter and Six
Months Ended June 30, 1999 and 1998.
Exhibit 12 - Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends.
Exhibit 27 - Financial Data Schedule (electronic filing only).
(b) Reports on Form 8-K: None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CAPSTEAD MORTGAGE CORPORATION
Date: August 11, 1999 By: /s/ RONN K. LYTLE
------------------------------------
Ronn K. Lytle
Chairman and Chief Executive Officer
Date: August 11, 1999 By: /s/ ANDREW F. JACOBS
------------------------------------
Andrew F. Jacobs
Executive Vice President - Finance
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INDEX TO EXHIBITS
EXHIBIT
NUMBERS DESCRIPTION
- ------- -----------
Exhibit 11 Computation of Earnings Per Share for the Quarter and Six
Months Ended June 30, 1999 and 1998.
Exhibit 12 Computation of Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividends
Exhibit 27 Financial Data Schedule (electronic filing only).