Capstead Mortgage Corp (CMO) 8-K Earnings Release

DALLAS – October 24, 2018 – Capstead Mortgage Corporation (“Capstead” or the “Company”) (NYSE: CMO) today announced financial results for the quarter ended September 30, 2018.

Third Quarter 2018 Summary

•	Generated earnings of $8.7 million or $0.04 per diluted common share

•	Paid common dividend of $0.11 per common share

•	Repurchased 1.4 million shares of common stock for $11.8 million, generating book value accretion of $0.03 per share

•	Book value per common share declined 3.0% or $0.30, excluding $0.07 of capital returned to stockholders in the form of dividends in excess of reported earnings, ending the quarter at $9.48 per common share

•	Net interest margins declined $3.7 million to $11.7 million as higher borrowing rates outstripped higher cash yields

•	Agency-guaranteed residential adjustable-rate mortgage (ARM) portfolio and leverage ended the quarter at $12.68 billion and 9.53 times long-term investment capital, respectively

About Capstead

Capstead is a self-managed real estate investment trust, or REIT, for federal income tax purposes. The Company earns income from investing in a leveraged portfolio of residential adjustable-rate mortgage pass-through securities, referred to as ARM securities, issued and guaranteed by government-sponsored enterprises, either Fannie Mae or Freddie Mac, or by an agency of the federal government, Ginnie Mae.

Third Quarter Earnings and Related Discussion

Capstead reported net income of $8.7 million or $0.04 per diluted common share for the quarter ended September 30, 2018. This compares to net income of $13.0 million or $0.09 per diluted common share for the quarter ended June 30, 2018. The Company paid a third quarter 2018 dividend of $0.11 per common share on October 19, 2018.

Portfolio yields averaged 2.08% during the third quarter of 2018, an increase of eight basis points from the 2.00% reported for the second quarter. Cash yields (yields on the portfolio before investment premium amortization) increased 14 basis points to average 3.07% during the third quarter, benefiting from mortgage loans underlying the portfolio resetting to higher rates based on higher prevailing six- and 12-month interest rate indices and higher coupon interest rates on recent acquisitions. As of September 30, 2018, 51% of the Company’s ARM securities portfolio will reset in rate on average in approximately six months, allowing the Company’s cash yields to

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continue benefiting from higher prevailing interest rates in future quarters. Yield adjustments for investment premium amortization increased six basis points to average a negative 0.99% for the third quarter. Mortgage prepayment rates averaged an annualized constant prepayment rate, or CPR, of 25.71%, an increase of 1.89% CPR from an average of 23.82% CPR the previous quarter. This increase was driven largely by seasonal factors, including the summer home selling season as well as refinance opportunities for eligible homeowners with currently resetting mortgages.

The following table illustrates the progression of Capstead’s portfolio of residential mortgage investments for the quarter and nine months ended September 30, 2018 (dollars in thousands):

	Quarter Ended September 30, 2018			Nine Months Ended September 30, 2018
Residential mortgage investments, beginning of period	$	13,017,107		$	13,454,098
Portfolio acquisitions (principal amount)		728,340			2,111,736
Investment premiums on acquisitions*		15,051			47,234
Portfolio runoff (principal amount)		(1,019,582	)		(2,755,648	)
Investment premium amortization		(32,354	)		(88,293	)
Decrease in net unrealized gains on securities classified as available-for-sale		(26,771	)		(87,336	)
Residential mortgage investments, end of period	$	12,681,791		$	12,681,791
Decrease in residential mortgage investments during the indicated periods	$	(335,316	)	$	(772,307	)

Residential mortgage investments typically are acquired at a premium to the securities’ unpaid principal balances. Investment premiums are recognized in earnings as portfolio yield adjustments using the interest method over the estimated lives of the related investments. As such, the level of mortgage prepayments impacts how quickly investment premiums are amortized.

Rates on Capstead’s $11.62 billion in secured borrowings, after adjusting for hedging activities, averaged 20 basis points higher at 1.82% during the third quarter of 2018, compared to 1.62% for the prior quarter. Average unhedged secured borrowing rates increased 24 basis points during the third quarter to 2.21%. This increase is largely attributable to the funding market’s response to 25 basis point increases in the Federal Funds Rate in June 2018 and, to a lesser extent, September 2018. Related hedged borrowing rates increased 16 basis points to 1.52% primarily due to $400 million of lower fixed-rate swaps maturing during the third quarter as well as the full quarter impact of $600 million of second quarter swap maturities. The Company typically uses two- and three-year term interest rate swap agreements with variable rate receipts based primarily on three-month LIBOR to help mitigate exposure to rising short-term interest rates. At quarter-end the Company held $6.55 billion notional amount of portfolio financing-related swap agreements with contract expirations occurring at various dates through the second quarter of 2021, and a weighted average expiration of 11 months.

Capstead operates a highly efficient investment platform, particularly compared to other mortgage REITs, and has a competitive cost structure relative to a wide variety of high yielding investment vehicles. Operating costs expressed as an annualized percentage of long-term investment capital averaged 0.98% for the third quarter of 2018 and 0.92% year-to-date. As an annualized percentage of total assets, operating costs averaged 0.09% during these periods.

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Common Stock Repurchases

Pursuant to its $100 million stock repurchase program reactivated last November, the Company repurchased 1.4 million shares of its common stock in the open market for $11.8 million during the third quarter of 2018. At an average repurchase price, including underwriting fees, of $8.25, these repurchases resulted in book value accretion of nearly $0.03 per share. Approximately $55 million remains under the repurchase program authorization. Future levels of stock repurchases will largely be dependent upon market conditions, including alternative capital investment opportunities, and are subject to applicable trading restrictions.

Long-Term Investment Capital and Portfolio Leverage

Capstead’s long-term investment capital, which consists of common and perpetual preferred stockholders’ equity and long-term unsecured borrowings, decreased by $47.7 million during the third quarter of 2018 to $1.22 billion primarily as a result of declines in portfolio valuations as well as common stock repurchases, dividend distributions in excess of earnings and decreases in swap gains. Portfolio leverage (secured borrowings divided by long-term investment capital) increased to 9.53 to one at September 30, 2018 from 9.42 to one at June 30, 2018.

Book Value per Common Share

The Company’s investment strategy attempts to mitigate risks to book value by focusing on investments in agency-guaranteed residential mortgage pass-through securities, which are considered to have little, if any, credit risk and are collateralized by ARM loans with interest rates that reset periodically to more current levels, generally within five years.

The following table illustrates the progression of the Company’s book value per common share (total stockholders’ equity, less preferred share liquidation preferences, divided by shares of common stock outstanding) as well as changes in book value expressed as percentages of beginning book value for the quarter and nine months ended September 30, 2018:

	Quarter Ended September 30, 2018					Nine Months Ended September 30, 2018
Book value per common share, beginning of period	$	9.85				$	10.25
Change in net unrealized gains and losses on mortgage securities classified as available-for-sale		(0.29	)				(0.96	)
Change in net unrealized gains and losses on interest rate swap agreements designated as cash flow hedges of:
Secured borrowings		(0.07	)				0.11
Unsecured borrowings		0.03					0.12
		(0.33	)	(3.4	)%		(0.73	)	(7.1	)%
Capital transactions:
Accretion from common stock repurchases		0.03					0.09
Dividend distributions in excess of earnings		(0.07	)				(0.12	)
Stock compensation-related activity		–					(0.01	)
		(0.04	)	(0.4	)%		(0.04	)	(0.4	)%
Book value per common share, end of period	$	9.48				$	9.48
Decrease in book value per common share during the indicated periods	$	(0.37	)	(3.8	)%	$	(0.77	)	(7.5	)%

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Nearly all of Capstead’s residential mortgage investments and all interest rate swap agreements are reflected at fair value on the Company’s balance sheet and related unrealized gains and losses are included in the calculation of book value per common share. Fair value is impacted by market conditions, including changes in interest rates, and the availability of financing at reasonable rates and leverage levels, among other factors. Because of these characteristics, the fair value of the Company’s portfolio is expected to be less vulnerable to significant pricing declines caused by credit concerns or rising interest rates compared to leveraged portfolios containing a significant amount of non-agency-guaranteed securities or agency-guaranteed securities backed by longer-duration ARM or fixed-rate loans.

Management Remarks

Commenting on current operating and market conditions, Phillip A. Reinsch, President and Chief Executive Officer, said, “Earnings in recent quarters have been hampered by increased mortgage prepayment activity and higher borrowing costs. This has occurred despite higher cash yields on acquisitions and on the currently-resetting portion of our portfolio of agency-guaranteed ARM securities.

“Cash yields are expected to continue improving through acquisitions and coupon resets with just over half of our portfolio scheduled to reset in rate on average in approximately six months, primarily based on six- and 12-month indices that have increased considerably since the beginning of the year. This key feature of our short duration ARM strategy affords us the opportunity over time to recover financing spreads diminished by rising borrowing rates. Additionally, as securities reset higher in rate and continue to season, we anticipate improvements in valuation over time. For more information regarding coupon resets see the last page of this release.

“With the conclusion of the summer home selling season and with other seasonal factors turning favorable, mortgage prepayment rates for the first month of the fourth quarter declined and recent increases in prevailing mortgage rates should allow for further moderation in CPRs this winter.

“With the Federal Reserve increasingly likely to continue raising rates into 2019, unhedged borrowing costs will likely continue trending higher in future quarters, while hedging costs will reflect higher prevailing interest rates on new swaps compared to rates embedded in maturing contracts. In the near term, hedging costs are also beginning to fully reflect a recent narrowing of three-month LIBOR and one-month rates, reducing receive-variable swap receipts relative to unhedged borrowing costs.

“Despite these near-term headwinds, we remain committed to our strategy of operating a cost-effective, internally managed REIT investing in a leveraged portfolio of short duration agency-guaranteed residential ARM securities with the goal of generating attractive risk-adjusted returns over the long-term.”

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Earnings Conference Call Details

An earnings conference call and live audio webcast will be hosted Thursday, October 25, 2018 at 9:00 a.m. ET. The conference call may be accessed by dialing toll free (877) 505-6547 in the U.S., (855) 669-9657 for Canada, or (412) 902-6660 for international callers. A live webcast of the conference call can be accessed via the investor relations section of the Company’s website at www.capstead.com and an archive of the webcast will be available through January 25, 2019. An audio replay can be accessed one hour after the end of the conference call, also through January 25, 2019, by dialing toll free (877) 344-7529 in the U.S., (855) 669-9658 for Canada, or (412) 317-0088 for international callers and entering conference number 10125280.

Statement Concerning Forward-looking Statements

This document contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “will be,” “will likely continue,” “will likely result,” or words or phrases of similar meaning. Actual results could differ materially from those projected in these forward-looking statements due to a variety of factors, without limitation, fluctuations in interest rates, the availability of suitable qualifying investments, changes in mortgage prepayments, the availability and terms of financing, changes in market conditions as a result of federal corporate and individual tax reform, changes in legislation or regulation affecting the mortgage and banking industries or Fannie Mae, Freddie Mac or Ginnie Mae securities, the availability of new investment capital, the liquidity of secondary markets and credit markets, and other changes in general economic conditions. These and other applicable uncertainties, factors and risks are described more fully in the Company’s filings with the U.S. Securities and Exchange Commission. Forward-looking statements speak only as of the date the statement is made and the Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, readers of this document are cautioned not to place undue reliance on any forward-looking statements included herein.

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CAPSTEAD MORTGAGE CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except ratios, pledged and per share amounts)


	September 30, 2018			December 31, 2017
	(unaudited)
Assets
Residential mortgage investments ($12.25 and $12.98 billion pledged at September 30, 2018 and December 31, 2017, respectively)	$	12,681,791		$	13,454,098
Cash collateral receivable from interest rate swap counterparties		26,293			42,506
Cash and cash equivalents		31,725			103,907
Receivables and other assets		152,216			132,938
	$	12,892,025		$	13,733,449
Liabilities
Secured borrowings	$	11,619,966		$	12,331,060
Interest rate swap agreements at fair value		13,012			23,772
Unsecured borrowings		98,266			98,191
Common stock dividend payable		10,365			18,487
Accounts payable and accrued expenses		29,323			23,063
		11,770,932			12,494,573
Stockholders’ equity
Preferred stock - $0.10 par value; 100,000 shares authorized: 7.50% Cumulative Redeemable Preferred Stock, Series E, 10,329 shares issued and outstanding ($258,226 aggregate liquidation preference) at September 30, 2018 and December 31, 2017		250,946			250,946
Common stock - $0.01 par value; 250,000 shares authorized: 91,068 and 95,698 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively		911			957
Paid-in capital		1,220,415			1,271,425
Accumulated deficit		(346,570	)		(346,570	)
Accumulated other comprehensive income		(4,609	)		62,118
		1,121,093			1,238,876
	$	12,892,025		$	13,733,449

Long-term investment capital (consists of stockholders’ equity and unsecured borrowings) (unaudited)	$	1,219,359		$	1,337,067
Portfolio leverage (secured borrowings divided by long-term investment capital) (unaudited)	9.53:1			9.22:1
Book value per common share (based on common shares outstanding and calculated assuming liquidation preferences for preferred stock) (unaudited)	$	9.48		$	10.25

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CAPSTEAD MORTGAGE CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share amounts)

(unaudited)

	Quarter Ended September 30						Nine Months Ended September 30
	2018			2017			2018			2017
Interest income:
Residential mortgage investments	$	67,649		$	57,073		$	201,989		$	168,017
Other		350			366			1,063			757
		67,999			57,439			203,052			168,774
Interest expense:
Secured borrowings		(54,393	)		(36,655	)		(147,655	)		(98,745	)
Unsecured borrowings		(1,910	)		(1,910	)		(5,701	)		(5,701	)
		(56,303	)		(38,565	)		(153,356	)		(104,446	)
		11,696			18,874			49,696			64,328
Other revenue (expense):
Compensation-related expense		(1,913	)		(1,073	)		(5,521	)		(4,021	)
Other general and administrative expense		(1,184	)		(1,097	)		(3,320	)		(3,435	)
Miscellaneous other revenue		81			48			233			130
		(3,016	)		(2,122	)		(8,608	)		(7,326	)
Net income	$	8,680		$	16,752		$	41,088		$	57,002
Net income available to common stockholders:
Net income	$	8,680		$	16,752		$	41,088		$	57,002
Less preferred stock dividends		(4,842	)		(4,718	)		(14,526	)		(12,600	)
	$	3,838		$	12,034		$	26,562		$	44,402

Net income per common share:
Basic and diluted	$	0.04		$	0.13		$	0.29		$	0.46

Weighted average common shares outstanding:
Basic		91,206			95,792			92,202			95,768
Diluted		91,346			95,923			92,317			95,905

Cash dividends declared per share:
Common	$	0.11		$	0.19		$	0.41		$	0.61
Series E preferred		0.47			0.47			1.41			1.41

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CAPSTEAD MORTGAGE CORPORATION

QUARTERLY STATEMENTS OF INCOME AND SELECT OPERATING STATISTICS

(unaudited, in thousands, except per share amounts, percentages annualized)

	2018									2017
	Q3			Q2			Q1			Q4			Q3			Q2
Quarterly Statements of Income:
Interest income:
Residential mortgage investments	$	67,649		$	65,202		$	69,138		$	64,418		$	57,073		$	56,103
Other		350			305			408			207			366			238
		67,999			65,507			69,546			64,625			57,439			56,341
Interest expense:
Secured borrowings		(54,393	)		(48,241	)		(45,021	)		(40,012	)		(36,655	)		(33,850	)
Unsecured borrowings		(1,910	)		(1,900	)		(1,891	)		(1,909	)		(1,910	)		(1,900	)
		(56,303	)		(50,141	)		(46,912	)		(41,921	)		(38,565	)		(35,750	)
		11,696			15,366			22,634			22,704			18,874			20,591
Other revenue (expense):
Compensation-related expense		(1,913	)		(1,560	)		(2,048	)		(894	)		(1,073	)		(1,833	)
Other general and administrative expense		(1,184	)		(899	)		(1,237	)		(1,254	)		(1,097	)		(1,276	)
Miscellaneous other revenue		81			81			71			2,031			48			67
		(3,016	)		(2,378	)		(3,214	)		(117	)		(2,122	)		(3,042	)
Net income	$	8,680		$	12,988		$	19,420		$	22,587		$	16,752		$	17,549
Net income per diluted common share	$	0.04		$	0.09		$	0.16		$	0.19		$	0.13		$	0.14
Average diluted common shares outstanding		91,346			92,121			93,506			95,658			95,923			95,916

Select Operating Statistics:
Average portfolio outstanding (cost basis)	$	13,026,636		$	13,025,353		$	13,303,044		$	13,502,798		$	13,513,833		$	13,501,791
Average long-term investment capital (“LTIC”)		1,258,367			1,280,231			1,314,537			1,362,700			1,353,859			1,358,646
Investment premium amortization		32,354			30,319			25,620			29,773			34,950			33,661
Constant prepayment rate (“CPR”)		25.71	%		23.82	%		19.64	%		22.50	%		25.77	%		24.69	%
Total financing spreads		0.21			0.33			0.55			0.56			0.46			0.52
Financing spreads on residential mortgage investments, a non-GAAP financial measure		0.26			0.38			0.61			0.62			0.52			0.58
Operating costs as a percentage of LTIC		0.98			0.77			1.01			0.62			0.64			0.92
Return on common equity capital		1.69			3.51			6.12			6.95			4.61			5.13

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CAPSTEAD MORTGAGE CORPORATION

QUARTERLY FINANCING SPREADS AND CPR

(annualized, unaudited)

	2018									2017												2016
	Q3			Q2			Q1			Q4			Q3			Q2			Q1			Q4
Total financing spreads: ^(a)
Yields on all interest-earning assets		2.08	%		2.00	%		2.07	%		1.90	%		1.68	%		1.65	%		1.67	%		1.49	%
Borrowing rates on all interest-paying liabilities		1.87			1.67			1.52			1.34			1.22			1.13			0.99			0.94
Total financing spreads		0.21			0.33			0.55			0.56			0.46			0.52			0.68			0.55
Financing spreads on residential mortgage investments, a non-GAAP financial measure:
Cash yields on residential mortgage investments ^(b)		3.07			2.93			2.85			2.79			2.72			2.66			2.60			2.55
Investment premium amortization ^(b)		(0.99	)		(0.93	)		(0.77	)		(0.88	)		(1.03	)		(1.00	)		(0.93	)		(1.05	)
Yields on residential mortgage investments		2.08			2.00			2.08			1.91			1.69			1.66			1.67			1.50
Unhedged secured borrowing rates ^(c)		2.21			1.97			1.64			1.39			1.33			1.09			0.89			0.79
Hedged secured borrowing rates ^(c)		1.52			1.36			1.35			1.23			1.10			1.08			0.96			0.95
Secured borrowing rates		1.82			1.62			1.47			1.29			1.17			1.08			0.93			0.89
Financing spreads on residential mortgage investments		0.26			0.38			0.61			0.62			0.52			0.58			0.74			0.61
CPR		25.71			23.82			19.64			22.50			25.77			24.69			22.93			25.59

(a)

All interest-earning assets include residential mortgage investments, overnight investments and cash collateral receivable from interest rate swap counterparties. All interest-paying liabilities include unsecured borrowings and cash collateral payable to interest rate swap counterparties.

(b)

Cash yields are based on the cash component of interest income. Investment premium amortization is determined using the interest method which incorporates actual and anticipated future mortgage prepayments. Both are expressed as a percentage calculated on average amortized cost basis for the indicated periods.

(c)

Unhedged borrowing rates represent average rates on secured borrowings, before consideration of related interest rate swap agreements. Hedged borrowing rates represent average fixed-rate payments made on interest rate swap agreements held for portfolio hedging purposes adjusted for differences between LIBOR-based variable-rate receipts on these swaps and unhedged borrowing rates, as well as the effects of any hedge ineffectiveness. Average fixed-rate swap payments were 1.66%, 1.53% and 1.34% for the third, second and first quarters of 2018, respectively, while variable-rate receipt adjustments and clearing fees averaged (0.13)%, (0.17)% and 0.01% for the same periods. During 2017, fixed-rate swap payments averaged 1.04% while variable-rate receipt adjustments averaged 0.05%.

Financing spreads on residential mortgage investments, a non-GAAP financial measure, differ from total financing spreads, an all-inclusive GAAP measure, that is based on all interest-earning assets and all interest-paying liabilities. Management believes that presenting financing spreads on residential mortgage investments provides useful information for evaluating the performance of the Company’s portfolio. The following reconciles these two measures:

2018

2017

2016

Total financing spreads

0.21

Capstead Mortgage Corp (CMO) SEC Filing 8-K Material Event for the period ending Wednesday, October 24, 2018

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