-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, G4r9/aogNU8Yfo1DLWbl8ZBPffJa1GM04cxptNOLzyQvK4t1ZxWCGhEQmYaiNDSB fambYaeNvl+8MZPp3jbpzA== 0000950134-99-003894.txt : 19990513 0000950134-99-003894.hdr.sgml : 19990513 ACCESSION NUMBER: 0000950134-99-003894 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990512 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPSTEAD MORTGAGE CORP CENTRAL INDEX KEY: 0000766701 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 752027937 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-08896 FILM NUMBER: 99617993 BUSINESS ADDRESS: STREET 1: 2711 NORTH HASKELL AVE STREET 2: STE 900 CITY: DALLAS STATE: TX ZIP: 75204 BUSINESS PHONE: 2148742323 MAIL ADDRESS: STREET 1: 2711 NORTH HASKELL AVENUE STREET 2: STE 900 CITY: DALLAS STATE: TX ZIP: 75204 FORMER COMPANY: FORMER CONFORMED NAME: LOMAS MORTGAGE CORP DATE OF NAME CHANGE: 19891105 10-Q 1 FORM 10-Q FOR QUARTER ENDED MARCH 31, 1999 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 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.) 2711 NORTH HASKELL, DALLAS, TEXAS 75204 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (214) 874-2323 Indicate by check mark whether the Registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practicable date. Common Stock ($0.01 par value) 58,338,720 as of May 3, 1999 ================================================================================ 2 CAPSTEAD MORTGAGE CORPORATION FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 1999 INDEX
PAGE ---- PART I. -- FINANCIAL INFORMATION ITEM 1. Financial Statements Consolidated Balance Sheet -- March 31, 1999 and December 31, 1998.............. 3 Consolidated Statement of Operations -- Quarter Ended March 31, 1999 and 1998... 4 Consolidated Statement of Cash Flows -- Quarter Ended March 31, 1999 and 1998... 4 Notes to Consolidated Financial Statements...................................... 5 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 13 ITEM 3. Qualitative and Quantitative Disclosure of Market Risk..................... 23 PART II. -- OTHER INFORMATION ITEM 6. Exhibits and Reports on Form 8-K........................................... 23 SIGNATURES......................................................................... 24
-2- 3 PART I. -- FINANCIAL INFORMATION CAPSTEAD MORTGAGE CORPORATION CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ITEM 1. FINANCIAL STATEMENTS
March 31, 1999 December 31, 1998 -------------- ----------------- (unaudited) ASSETS Mortgage securities and other investments $ 5,387,676 $ 2,369,602 CMO collateral and investments 4,039,550 4,571,274 ----------- ----------- 9,427,226 6,940,876 Prepaids, receivables and other 50,348 59,526 Cash and cash equivalents 8,025 73,385 Restricted cash 25,208 26,500 ----------- ----------- $ 9,510,807 $ 7,100,287 =========== =========== LIABILITIES Short-term borrowings $ 4,802,199 $ 1,839,868 Collateralized mortgage obligations 4,001,716 4,521,324 Accounts payable and accrued expenses 18,313 58,894 ----------- ----------- 8,822,228 6,420,086 ----------- ----------- STOCKHOLDERS' EQUITY Preferred stock - $0.10 par value; 100,000 shares authorized: $1.60 Cumulative Preferred Stock, Series A, 374 shares issued ($6,134 aggregate liquidation preference) 5,228 5,228 $1.26 Cumulative Convertible Preferred Stock, Series B, 17,179 and 17,298 shares issued ($195,497 aggregate liquidation preference) 191,871 193,196 Common stock - $0.01 par value; 100,000 shares authorized; 58,702 and 60,546 shares issued 587 605 Paid-in capital 778,391 787,677 Undistributed income (loss) (297,065) (305,287) Accumulated other comprehensive income (loss) 9,567 (1,218) ----------- ----------- 688,579 680,201 ----------- ----------- $ 9,510,807 $ 7,100,287 =========== ===========
See accompanying notes to consolidated financial statements. -3- 4 CAPSTEAD MORTGAGE CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
Quarter Ended March 31 ---------------------- 1999 1998 --------- --------- INTEREST INCOME: Mortgage securities and other investments $ 47,312 $ 98,784 CMO collateral and investments 77,030 94,235 --------- --------- Total interest income 124,342 193,019 --------- --------- INTEREST AND RELATED EXPENSE: Short-term borrowings: Mortgage securities and other investments 33,914 88,410 CMO investments -- 11,326 Collateralized mortgage obligations 77,517 77,803 Mortgage insurance and other 627 1,112 --------- --------- Total interest and related expense 112,058 178,651 --------- --------- Net margin on mortgage assets and other investments 12,284 14,368 --------- --------- NET MARGIN ON MORTGAGE BANKING OPERATIONS -- 14,845 --------- --------- OTHER OPERATING REVENUE (EXPENSE): Gain on sale of mortgage assets and derivative financial instruments 1,738 6,869 CMO administration and other 1,470 829 Other operating expense (1,585) (1,841) --------- --------- Total other operating revenue (expense) 1,623 5,857 --------- --------- NET INCOME $ 13,907 $ 35,070 ========= ========= Net income $ 13,907 $ 35,070 Less cash dividends on preferred stock (5,684) (5,555) --------- --------- Net income available to common stockholders $ 8,223 $ 29,515 ========= ========= NET INCOME PER COMMON SHARE: Basic $ 0.14 $ 0.50 Diluted 0.14 0.48 CASH DIVIDENDS PAID PER SHARE: Common $ -- $ 0.500 Series A Preferred 0.400 0.400 Series B Preferred 0.315 0.315
See accompanying notes to consolidated financial statements. -4- 5 CAPSTEAD MORTGAGE CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
Quarter Ended March 31 -------------------------- 1999 1998 ----------- ----------- OPERATING ACTIVITIES: Net income $ 13,907 $ 35,070 Noncash items: Amortization of mortgage servicing rights and related costs -- 19,928 Amortization of discount and premium 11,409 42,563 Depreciation and other amortization 286 1,465 Gain on sale of mortgage assets and derivative financial instruments (1,738) (6,826) Net change in prepaids, receivables, other assets, accounts payable and accrued expenses (31,912) (4,259) ----------- ----------- Net cash provided (used) by operating activities (8,048) 87,941 ----------- ----------- INVESTING ACTIVITIES: Purchases of mortgage securities and other investments (3,319,728) (1,778,499) Purchases of CMO collateral and investments -- (721,174) Purchases of mortgage servicing rights -- (39,832) Purchases of derivative financial instruments -- (54,250) Principal collections on mortgage investments 295,380 568,790 Proceeds from sales of mortgage assets 114,763 682,690 Proceeds from sales and settlement of derivative financial instruments 12,595 32,360 CMO collateral: Principal collections 404,123 202,891 Decrease in accrued interest receivable 3,607 1,841 Decrease (increase) in short-term investments 11,116 (2,509) ----------- ----------- Net cash used by investing activities (2,478,144) (1,107,692) ----------- ----------- FINANCING ACTIVITIES: Increase in short-term borrowings 2,962,331 678,220 Increase in mortgage servicing acquisitions payable -- 25,385 Collateralized mortgage obligations: Issuances of securities -- 597,934 Principal payments on securities (521,551) (264,118) Decrease in accrued interest payable (3,635) (1,012) Capital stock transactions (10,629) 28,843 Dividends paid (5,684) (35,633) ----------- ----------- Net cash provided by financing activities 2,420,832 1,029,619 ----------- ----------- Net change in cash and cash equivalents (65,360) 9,868 Cash and cash equivalents at beginning of period 73,385 17,377 ----------- ----------- Cash and cash equivalents at end of period $ 8,025 $ 27,245 =========== ===========
See accompanying notes to consolidated financial statements. -5- 6 CAPSTEAD MORTGAGE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 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. With the restructuring of the Company's mortgage asset portfolios that began in June 1998 and the sale of the mortgage banking operations in December 1998, the Company has excess capital and liquidity of more than $450 million. Currently, the Company is investing its excess liquidity primarily in mortgage-backed securities issued by government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities"). In addition, the Company continues to evaluate a number of opportunities to acquire or make strategic investments in a variety of real estate-related investments and entities. However, the Company may conclude 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 ended March 31, 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. 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"). Subsequently the Company repurchased, as of March 31, 1999, 1,759,600 shares of common stock at an average price of $5.09 (including transaction costs) and 118,600 shares of the Series B Preferred Stock at an average price of $11.99 (including transaction costs). 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 another 85,583 shares were repurchased from employees at $4.12 per share in connection with the lapsing of restrictions on stock awards with the December 1998 sale of the mortgage banking operations. Altogether the Company has repurchased over 4.5 percent of its outstanding shares of common stock since the first share repurchases in December 1998. All such repurchased shares have been canceled and returned to authorized but unissued shares. On April 22, 1999 the board of directors declared a first quarter dividend of 14 cents per common share, payable May 20, 1999 to stockholders of record as of May 3, 1999. -6- 7 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):
Average Principal Premium Carrying Average Effective Balance (Discount) Basis Amount Coupon Rate ----------- ----------- ----------- ----------- ------- --------- * ** ** MARCH 31, 1999 Agency Securities: FNMA/FHLMC: Fixed-rate $ 1,103,896 $ (3,284) $ 1,100,612 $ 1,097,365 6.17% 6.31% Medium-term 846,244 5,909 852,153 854,509 6.24 5.83 Adjustable-rate ("ARMs"): LIBOR/CMT 928,055 22,598 950,653 951,179 7.23 5.22 COFI 252,338 1,669 254,007 253,836 5.94 6.19 GNMA ARMs 2,065,561 33,472 2,099,033 2,106,234 6.32 5.67 Non-agency securities: Fixed-rate 123,729 167 123,896 124,553 8.54 8.24 Mortgage loans held for sale*** -- -- -- -- -- 6.51 ----------- ----------- ----------- ----------- $ 5,319,823 $ 60,531 $ 5,380,354 $ 5,387,676 =========== =========== =========== =========== 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 Non-agency securities: Fixed-rate 34,826 (11) 34,815 35,671 8.57 8.54 Mortgage loans held for sale*** 105,892 (146) 105,746 105,746 6.77 6.79 ----------- ----------- ----------- ----------- $ 2,339,895 $ 33,694 $ 2,373,589 $ 2,369,602 =========== =========== =========== ===========
* 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. *** Represents loans originated prior to the sale of the mortgage banking operations in December 1998. All such loans have been subsequently sold. 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 -7- 8 adjustment, or (iii) fixed-rate mortgage securities that have expected weighted average lives of 5 years or 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 (i) 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, (ii) other AAA-rated private mortgage securities, or (iii) single-family residential mortgage loans held for sale in connection with loan production activities (collectively, "Non-agency Securities"). 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):
March 31, 1999 December 31, 1998 -------------- ----------------- Pledged CMO Collateral: Pledged mortgage securities $3,996,256 $4,507,337 Short-term investments 3,762 14,879 Accrued interest receivable 23,755 27,361 ---------- ---------- 4,023,773 4,549,577 Unamortized premium 12,145 11,830 ---------- ---------- 4,035,918 4,561,407 CMO investments 3,632 9,867 ---------- ---------- $4,039,550 $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 $1.2 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 7.19 percent during the quarter ended March 31, 1999. -8- 9 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):
March 31, 1999 December 31, 1998 -------------- ----------------- CMOs $ 3,994,489 $ 4,513,522 Accrued interest payable 21,974 25,609 ----------- ----------- Total obligation 4,016,463 4,539,131 Unamortized discount (14,747) (17,807) ----------- ----------- $ 4,001,716 $ 4,521,324 =========== =========== Range of average interest rates 5.12% to 9.45% 5.22% to 9.45% Range of stated maturities 2008 to 2028 2007 to 2028 Number of series 27 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 7.31 percent during the quarter ended March 31, 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. -9- 10 The following table summarizes fair value disclosures for available-for-sale debt securities (in thousands):
Gross Gross Unrealized Unrealized Fair Basis Gains Losses Value ---------- ---------- ---------- ---------- AS OF MARCH 31, 1999 Agency Securities: FNMA/FHLMC: Fixed-rate $1,100,612 $ 1,014 $ 4,261 $1,097,365 Medium-term 852,153 2,547 191 854,509 ARMs: LIBOR/CMT 950,653 3,717 3,191 951,179 COFI 254,007 40 211 253,836 GNMA ARMs 2,099,033 7,842 641 2,106,234 Non-agency Securities: Fixed-rate 27,645 657 -- 28,302 CMO collateral and investments 156,093 2,346 101 158,338 ---------- ---------- ---------- ---------- $5,440,196 $ 18,163 $ 8,596 $5,449,763 ========== ========== ========== ========== 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 Non-agency Securities: Fixed-rate 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 ========== ========== ========== ==========
The Company currently has the ability to hold mortgage assets for the foreseeable future and, therefore, does not expect to realize losses on security sales. 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 tables summarize fair value disclosures for debt securities held-to-maturity (in thousands):
Gross Gross Unrealized Unrealized Fair Basis Gains Losses Value ---------- ---------- ---------- ---------- AS OF MARCH 31, 1999 Pledged CMO Collateral $3,881,212 $ 2,735 $ 22,699 $3,861,248 Non-agency Securities: Fixed-rate 96,251 2,121 -- 98,372 ---------- ---------- ---------- ---------- $3,977,463 $ 4,856 $ 22,699 $3,959,620 ========== ========== ========== ========== AS OF DECEMBER 31, 1998 Pledged CMO Collateral $4,377,589 $ 3,286 $ 26,359 $4,354,516 ========== ========== ========== ==========
-10- 11 Sales of released CMO collateral occasionally occur provided the collateral has paid down to within 15 percent of its original issuance amounts. The following table summarizes disclosures related to dispositions of debt securities (in thousands):
Quarter Ended March 31 ---------------------- 1999 1998 --------- -------- Sale of securities held available-for-sale: Amortized cost $ 7,573 $651,473 Gains* 1,761 4,721 Redemption of callable agency notes and sale of released CMO collateral held-to-maturity: Amortized cost -- 5,022 Gains -- 471
* Excludes net 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 March 31 -------------------- 1999 1998 -------- -------- Net income $ 13,907 $ 35,070 Other comprehensive income (loss): Unrealized gain (loss) on debt securities: Change in unrealized gain (loss) during period 12,546 (55,770) Reclassification adjustment for gain included in net income (1,761) (4,721) -------- -------- Other comprehensive income (loss) 10,785 (60,491) -------- -------- Comprehensive income (loss) $ 24,692 $(25,421) ======== ========
NOTE 9 -- NET INTEREST INCOME ANALYSIS The following table summarizes interest income and interest expense and average effective interest rates for the periods indicated (dollars in thousands):
Quarter Ended March 31 ------------------------------------------- 1999 1998 -------------------- -------------------- Amount Average Amount Average -------- ------- -------- ------- Interest income: Mortgage securities and other investments $ 47,312 5.78% $ 98,784 6.17% CMO collateral and investments 77,030 7.20 94,235 7.18 -------- -------- Total interest income 124,342 193,019 -------- -------- Interest expense: Short-term borrowings 33,914 4.95 99,736 5.63 CMOs 77,517 7.31 77,803 7.36 -------- -------- Total interest expense 111,431 177,539 -------- -------- Net interest $ 12,911 $ 15,480 ======== ========
-11- 12 The following table summarizes increases (decreases) in interest income and interest expense due to changes in interest rates versus changes in volume for the quarter ended March 31, 1999 compared to the same period in 1998 (in thousands):
Rate* Volume* Total -------- -------- -------- Interest income: Mortgage securities and other investments $ (5,939) $(45,533) $(51,472) CMO collateral and investments 196 (17,401) (17,205) -------- -------- -------- Total interest income (5,743) (62,934) (68,677) -------- -------- -------- Interest expense: Short-term borrowings (10,697) (55,125) (65,822) CMOs (540) 254 (286) -------- -------- -------- Total interest expense (11,237) (54,871) (66,108) -------- -------- -------- Net interest $ 5,494 $ (8,063) $ (2,569) ======== ======== ========
* The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. NOTE 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 price of the Company's equity securities were artificially inflated during that time period. The complaints seek monetary damages in an undetermined amount. In March 1999 these actions were consolidated. The date by which the Company is to respond has not yet run. The Company believes it has meritorious defenses to the claims and intends to vigorously defend the actions. Based on available information, management believes the resolution of these suits will not have a material adverse effect on the financial position of the Company. -12- 13 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 deteriorating market conditions, in June 1998 the Company began restructuring its mortgage asset portfolios and in December 1998 closed the sale of its mortgage banking operations. The Company entered 1999 with substantial liquidity but diminished earning capacity. Since year-end, the mortgage finance markets have generally improved with increasing market liquidity, slowing prepayment rates and declining borrowing rates. In early 1999, the Company began redeploying a portion of the proceeds from the sale of its mortgage banking operations to support increased holdings of mortgage-backed securities issued by government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities"). Purchases of Agency Securities totaled $3.3 billion during the quarter, increasing this portfolio to $5.3 billion by quarter-end. Average holdings of Agency Securities were $3.2 billion in the first quarter and this portfolio is expected to average approximately $5.2 billion in the second quarter. 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 7.1:1 at March 31, 1999. The Company's targeted leverage ratio is moderately higher than the quarter-end ratio; therefore, the Company may modestly increase its portfolio of Agency Securities in the future. The Company continues to evaluate a number of opportunities to acquire or make strategic investments in a variety of real estate-related investments and entities. However, the Company may conclude to substantially limit its activities to investing in Agency Securities. As of March 31, 1999, the Company had repurchased over 4.5 percent of its outstanding shares of common stock and a more modest number of shares 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 and net income per share. The Company averaged 60,138,000 common shares outstanding for the quarter ending March 31, 1999 and ended the quarter with 58,702,000 common shares outstanding. 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 (i) private mortgage pass-through securities whereby the related credit risk of the underlying loans is borne by AAA-rated private mortgage insurers, (ii) other AAA-rated private mortgage securities, or (iii) single-family residential mortgage loans held for sale in connection with curtailed loan production activities (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 -13- 14 securities and other investments are financed under repurchase arrangements with investment banking firms pursuant to which the portfolios are pledged as collateral (see "Liquidity and Capital Resources"). The following yield and cost analysis illustrates changes during the quarter in the Company's mortgage investment portfolio and its earnings capacity achieved through the acquisition of additional securities and improving market conditions:
Average for the Quarter Ended March 31, 1999 As of March 31, 1999 ------------------------------ -------------------------------------------------- Lifetime Actual Actual Premium Projected Prepayment Basis Yield/Cost Runoff (Discount) Basis Yield/Cost Assumptions ----------- ---------- ------ ----------- ----------- ---------- ----------- * * ** ** Agency securities: FNMA/FHLMC: Fixed-rate $ 590,551 6.31% 15% $ (3,284) $ 1,100,612 6.23% 10% Medium-term 480,296 5.83 33 5,909 852,153 5.80 30 ARMs: LIBOR/CMT 795,467 5.22 44 22,598 950,653 4.90 50 COFI 66,238 6.19 9 1,669 254,007 5.61 18 GNMA ARMs 1,269,977 5.67 33 33,472 2,099,033 5.45 30 ----------- ---- ---- ----------- ----------- ---- ---- 3,202,529 5.71 33 60,364 5,256,458 5.58 29 Non-agency securities: Fixed-rate 74,313 8.24 50 167 123,896 8.14 50 Mortgage loans held for sale 8,950 6.51 -- -- -- -- -- ----------- ---- ---- ----------- ----------- ---- ---- 3,285,792 5.77 33% $ 60,531 5,380,354 5.63 29% ==== =========== ==== Less short-term borrowings 2,743,947 4.95 4,802,199 4.87 ----------- ---- ----------- ---- Capital employed/ financing spread $ 541,845 0.82% $ 578,155 0.76% =========== ==== =========== ==== Return on assets*** 1.62% 1.29%
* Basis is the Company's investment before mark-to-market for securities classified as available-for-sale. ** 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 prepayment assumptions. The projected short-term borrowing rate reflects costs of borrowings as of quarter-end. *** The Company uses its excess capital to pay down short-term indebtedness. Return on assets is calculated giving the benefit of the reduction in interest costs from the use of capital, including excess capital currently invested in these portfolios. The Company acquired $722 million of fixed-rate, $575 million of medium-term, $682 million of Fannie Mae/Freddie Mac ARM and $1.3 billion of Ginnie Mae ARM Agency Securities during the current quarter, increasing its portfolio of Agency Securities to $5.3 billion at March 31, 1999 from $2.2 billion at December 31, 1998. The Company also called for redemption four series of collateralized mortgage obligations during the quarter returning $106 million of fixed-rate mortgage loans to its Non-agency Securities portfolio. Investments in fixed-rate mortgage securities, although higher in dollar terms, were little changed as a percentage of total mortgage investments (22.7 percent at March 31, 1999 compared to 22.9 percent at year-end). Medium-term mortgage securities increased to 15.9 percent at March 31, 1999 compared to 13.4 percent at year-end, while ARM investments represented 61.5 percent at quarter-end down from 63.7 percent. The Company's leverage ratio increased from 2.7:1 at year-end to 7.1:1 at March 31, 1999. The Company's targeted leverage ratio is moderately higher than the quarter-end ratio; therefore, the Company may modestly increase its portfolio of Agency Securities in the future. -14- 15 The premium paid for these portfolios, net of related amortization, increased to $60.5 million at March 31, 1999 from $33.7 million at year-end while actually declining as a percentage of these investments to 1.14 percent from 1.44 percent. This net premium paid is amortized to income as a yield adjustment based on both actual prepayments and lifetime prepayment assumptions. Actual prepayments declined throughout the quarter as mortgage interest rates increased. Prepayments on Fannie Mae and Freddie Mac medium-term and adjustable-rate ("ARM") Agency Securities declined from an annualized rate of 48.4 percent in December 1998 to 30.2 percent in March 1999. Prepayments on Ginnie Mae ARMs declined from an annualized rate of 37.9 percent in December 1998 to 31.2 percent in March 1999. Should actual prepayments continue to trend lower, the Company's lifetime prepayment assumptions may change, which could have a positive effect on future yields. Based on current expectations, barring an increase in short-term borrowing costs, the Company's overall financing spread for the second quarter is expected to be approximately the same as was achieved in the first quarter (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. 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 $1.2 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 1998 the Company disposed a $1.0 billion interest-only mortgage securities portfolio at a substantial loss and during the first quarter sold the remaining purchased interest-only mortgage securities. As of March 31, 1999, the Company's CMO investments had been reduced to $37.8 million, down from $50.0 million at December 31, 1998. Included in this net investment are $12.1 million and $14.7 million of remaining CMO collateral premiums and bond discounts, respectively. -15- 16 UTILIZATION OF CAPITAL AND POTENTIAL LIQUIDITY The following table summarizes the Company's utilization of capital and potential liquidity as of March 31, 1999 (in thousands):
Capital Potential Assets Borrowings Employed Liquidity ---------- ---------- ---------- --------- Agency securities: FNMA/FHLMC: Fixed-rate $1,097,365 $1,087,975 $ 9,390 $ (1,562) Medium-term 854,509 757,432 97,077 71,420 ARMs: LIBOR/CMT 951,179 770,974 180,205 151,979 COFI 253,836 248,451 5,385 (245) GNMA ARMs 2,106,234 1,937,367 168,867 106,166 Non-agency securities: Fixed-rate 124,553 - 124,553 121,697 CMO collateral and investments 4,039,550 4,001,716 37,834 7,500 ---------- ---------- ---------- --------- $9,427,226 $8,803,915 623,311 456,955 ========== ========== Other assets, net of other liabilities 65,268 8,025** ---------- --------- $ 688,579 $ 464,980 ========== =========
* Based on maximum borrowings available under existing uncommitted repurchase arrangements considering the fair value of related collateral as of March 31, 1999 (see "Liquidity and Capital Resources"). ** Represents unrestricted cash and cash equivalents. STOCK REPURCHASES AND BOOK VALUES PER COMMON SHARE 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). 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. Subsequently the Company repurchased, as of March 31, 1999, 1,759,600 shares of common stock at an average price of $5.09 (including transaction costs) and 118,600 shares of its Series B Preferred Stock at an average price of $11.99 (including transaction costs) pursuant to this repurchase program. In early January another 85,583 shares were repurchased from employees at $4.12 per share in connection with the lapsing of restrictions on stock awards with the December 1998 sale of the mortgage banking operations. Altogether the Company has repurchased over 4.5 percent of its outstanding shares of common stock since the first share repurchases 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 and net income per share. The Company averaged 60,138,000 common shares outstanding for the quarter ending March 31, 1999 and ended the quarter with 58,702,000 common shares outstanding. Book values per common share outstanding at the respective balance sheet dates were as follows:
March 31, 1999 December 31, 1998 -------------- ----------------- Calculated assuming liquidation of preferred stock* $8.30 $7.88 Calculated assuming redemption of preferred stock** 7.97 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. -16- 17 Of the 41 cent increase in book value per common share during the quarter ended March 31, 1999 (calculated assuming redemption of the Company's convertible preferred stock), 18 cents was attributable to the improvement in unrealized gains on securities held available-for-sale, 14 cents to undistributed income and 9 cents to the repurchase of common shares. RESULTS OF OPERATIONS Comparative net operating results (interest income or fee revenues, net of related interest expense and, in the case of mortgage banking and CMO administration, related direct and indirect operating expenses) by source were as follows (in thousands, except per share amounts):
Quarter Ended March 31 -------------------- 1999 1998 -------- -------- Agency Securities $ 11,817 $ 8,137 Non-agency Securities 1,529 1,807 CMO collateral and investments (1,062) 4,424 -------- -------- Net margin on mortgage assets and other investments 12,284 14,368 Mortgage banking operations -- 14,845 Other operating revenue (expense): Gain on sale of mortgage assets and derivative financial instruments 1,738 6,869 CMO administration and other 1,470 829 Other operating expense (1,585) (1,841) -------- -------- Net income $ 13,907 $ 35,070 ======== ======== Net income per common share: Basic $ 0.14 $ 0.50 Diluted 0.14 0.48
Operating results for the quarter ended March 31, 1999 were substantially less than results for the first quarter of 1998 which were achieved prior to a substantial downsizing of the Company's mortgage asset portfolios begun in June 1998 in response to deteriorating market conditions that culminated in the sale of the mortgage banking operations in the December 1998. The Company entered 1999 with substantial liquidity but diminished earning capacity. Since year-end, the mortgage finance markets have generally improved with increasing market liquidity, slowing prepayment rates and declining borrowing rates. In early 1999, the Company began redeploying a portion of the proceeds from the sale of its mortgage banking operations to increase holdings of Agency Securities and Non-agency Securities and invested its remaining excess capital and liquidity in its mortgage investment portfolios dramatically reducing borrowing costs. The earning capacity of the Company's mortgage asset portfolios are largely dependent on the extent to which the Company invests its excess capital and 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 is evaluating a number of opportunities to redeploy some portion of its excess capital into strategic investments in a variety of real estate-related investments and entities, although there can be no assurance that the Company will make any such investments. Additionally, a further steepening of the yield curve, whether through higher long-term interest rates or lower short-term interest rates, should improve the performance of the Company's mortgage asset portfolios (see "Effects of Interest Rate Changes"). -17- 18 Agency Securities contributed more to operating results during the first quarter of 1999 than the same period in 1998 despite a lower average outstanding portfolio due primarily to the investment of much of the Company's excess liquidity in this portfolio and, to a lesser extent, due to a 31-basis point increase in financing spreads to 76 basis points. On average, the Company employed $470 million of its capital to the Agency Securities portfolio during the current quarter compared to only $119 million during the same period in 1998. The average outstanding portfolio of $3.2 billion during the current quarter was 44 percent lower than during the same period in 1998. Yields for this portfolio averaged 5.71 percent during the current quarter compared to 6.06 percent during the same period in 1998, while average borrowing rates were significantly lower at 4.95 percent compared to 5.61 percent during the same period 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 underlying ARM loans reset periodically based on those indices and (iii) increased lifetime prepayment assumptions currently in use for amortizing purchased premiums. Non-agency Securities contributed less to operating results during the first quarter of 1999 than in the same period in 1998 due primarily to the investment of some of the Company's excess liquidity in this portfolio. The average outstanding portfolio was $83 million during the current quarter financed entirely by equity, compared to $681 million during the same period in 1998 during which time only $6 million of capital was employed supporting this portfolio. Since March 31, 1998 the size of this portfolio has declined because of runoff, sales and a $345 million CMO issuance offset to a degree by CMO redemptions. Average yields for this portfolio (calculated including mortgage insurance costs) were 8.05 percent during the first quarter compared to 6.82 percent during the same period in 1998. CMO collateral and investments contributed substantially less to operating results during the first quarter of 1999 than the same period in 1998 primarily because of the disposition of a $1 billion interest-only mortgage securities portfolio in June 1998, subsequent sales of remaining purchased interest-only mortgage securities and redemptions of CMOs, which 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, this portfolio is not expected to 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 first quarter of 1999, the Company settled approximately $18 million of this liability including a $16 million prepayment protection settlement payment and $1.3 million paid out of restricted cash for pricing adjustments on mortgage servicing rights acquisition agreements assumed by the buyer. Operating expenses during the first quarter of 1999 were less than in the same period in 1998 due to lower compensation costs and general and administrative costs as a direct result of the sale of the mortgage banking operations, offset by the elimination of allocations of certain of these costs to those operations. Ongoing operating expenses are expected to be at a similar level as incurred in the first quarter. During the first quarter of 1999 the Company recorded gains of $1,752,000 on the sale of its remaining $5.9 million of purchased interest-only mortgage securities held as CMO investments and $9,000 on the sale of $1.6 million of GNMA ARMs (this transaction was an accommodation to one of the Company's dealers). A net loss of $23,000 was recorded in disposing of remaining derivative financial instruments ("Derivatives") held in connection with the mortgage banking operations. This compares to sales of mortgage assets totaling $677 million during the same period of 1998 for gains of $5.3 million and $1.6 million earned writing call options on fixed-rate mortgage investments. -18- 19 LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of funds include monthly principal and interest payments on mortgage securities and other investments, short-term borrowings, excess cash flows on CMO investments and proceeds from sales of mortgage assets. In addition, the Company has substantial excess liquidity with the proceeds from the 1998 restructuring of its mortgage asset portfolios and the sale of its mortgage banking operations (see above "Financial Condition"), which have been deployed to reduce short-term borrowings. 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. 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 March 31, 1999, 4.2 million and 1.9 million shares of common and Series B Preferred Stock remained available for repurchase under this program, respectively. The Company may continue to repurchase the 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 any Derivatives held are included in this exercise. In addition, sensitivity of fee income to market interest rate levels, such as those related to CMO administration, are 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. -19- 20 As of March 31, 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* $ 24,822 $ 33,020 $14,148 $(23,704)
* 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 a 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 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 -20- 21 interest rates fall significantly below interest rates on the collateral, principal prepayments will 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 has disposed of substantially all 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. The Company supplements its business plan from time to time with Derivatives held to help offset the effects of falling interest rates on the value of certain assets, such as interest-only mortgage securities and mortgage servicing rights. Historically, most Derivatives used by the Company have been interest rate floors that generally decrease in value when interest rates rise and increase in value when rates decline. The fair value of interest rate floors will erode over time and, as seen in 1998, can also be impacted by other factors such as changes in market demand for these instruments. Other Derivatives acquired from time to time may include U.S. Treasury futures contracts and options, written options on mortgage assets or various other Derivatives available in the marketplace that are compatible with the Company's risk management objectives. In instances where such Derivatives are accorded hedge accounting treatment, changes in value adjust the basis of the assets hedged. In instances where Derivatives are not accorded hedge accounting treatment, changes in value are recorded in operating results as they occur, which can increase income volatility. 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. 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 -21- 22 necessary steps to become Year 2000 compliant. This process is expected to be essentially complete by the end of the second quarter of 1999. In addition, with the sale of the mortgage banking operations in December 1998, the Company has built a completely 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 $300,000. Risks and Contingency Planning. Although the Company expects that all its systems and applications will be Year 2000 compliant per the above schedule 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. -22- 23 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS The information required by this Item is incorporated by reference to the information included in Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations." PART II. -- OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: The following Exhibits are presented herewith: Exhibit 11 - Computation of Earnings Per Share for the quarter ended March 31, 1999 and 1998. Exhibit 12 - Capstead Mortgage Corporation and Subsidiaries 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: Current Report on Form 8-K and Amendment No. 1 to Current Report on Form 8-K both dated December 31, 1998 to file the following: Exhibit 2.1 - Asset Purchase Agreement dated as of December 10, 1998 by and among Capstead Mortgage Corporation, Capstead Holdings, Inc. and Capstead Inc. and Homecomings Financial Network, Inc. Exhibit 10.33 - Purchase and Sale Agreement dated as of November 30, 1998 by and among Capstead Inc. and GMAC Mortgage Corporation. Item 7. - Unaudited Pro Forma Financial Data - Unaudited Pro Forma Condensed Statement of Operations for the Year Ended December 31, 1998. -23- 24 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CAPSTEAD MORTGAGE CORPORATION Date: May 6, 1999 By: /s/ RONN K. LYTLE ------------------------------------- Ronn K. Lytle Chairman and Chief Executive Officer Date: May 6, 1999 By: /s/ ANDREW F. JACOBS ------------------------------------- Andrew F. Jacobs Executive Vice President - Finance, Treasurer and Secretary -24- 25 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 11 Computation of Earnings Per Share for the quarter ended March 31, 1999 and 1998. 12 Capstead Mortgage Corporation and Subsidiaries Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends. 27 Financial Data Schedule (electronic filing only).
EX-11 2 STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE 1 EXHIBIT 11 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES COMPUTATION OF NET INCOME PER SHARE (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Quarter Ended March 31 -------------------- 1999 1998 -------- -------- BASIC: Average number of common shares outstanding 60,138 59,594 ======== ======== Net income $ 13,907 $ 35,070 Less cash dividends paid on convertible preferred stock: Series A ($0.40 per share) (150) (160) Series B ($0.315 per share) (5,437) (5,395) Repurchase price in excess of recorded value (97) -- -------- -------- Net income available to common stockholders $ 8,223 $ 29,515 ======== ======== Basic net income per common share $ 0.14 $ 0.50 ======== ======== DILUTED:* Average number of common shares outstanding 59,594 Assumed conversion of convertible preferred stock Series A 827 Series B 12,416 Incremental shares calculated using the Treasury Stock method 555 -------- 73,392 ======== Net income $ 35,070 ======== Diluted net income per common share $ 0.14 $ 0.48 ======== ========
* The Series A and B Preferred Stock was not considered convertible for purposes of calculating diluted net income per common share for the quarter ended March 31, 1999 because the effects of conversion were antidilutive. EX-12 3 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES 1 EXHIBIT 12 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS (IN THOUSANDS, EXCEPT RATIOS) (UNAUDITED) (a) Computation of ratio of earnings to combined fixed charges and preferred stock dividends (including CMO debt):
Three Months Year Ended December 31 Ended ---------------------------------------------------------- March 31, 1999 1998 1997 1996 1995 1994 -------------- --------- --------- --------- --------- --------- Fixed charges $ 111,431 $ 673,233 $ 633,845 $ 598,312 $ 584,137 $ 474,844 Preferred stock dividends 5,684 22,342 25,457 36,356 39,334 38,876 --------- --------- --------- --------- --------- --------- Combined fixed charges and preferred stock dividends 117,115 695,575 659,302 634,668 623,471 513,720 Net income (loss) 13,907 (234,764) 159,926 127,228 77,359 85,579 --------- --------- --------- --------- --------- --------- Total $ 131,022 $ 460,811 $ 819,228 $ 761,896 $ 700,830 $ 599,299 ========= ========= ========= ========= ========= ========= Ratio of earnings to combined fixed charges and preferred stock dividends 1.12:1 0.66:1 1.24:1 1.20:1 1.12:1 1.17:1 ========= ========= ========= ========= ========= =========
(b) Computation of ratio of earnings to combined fixed charges and preferred stock dividends (excluding CMO debt):
Three Months Year Ended December 31 Ended ---------------------------------------------------------- March 31, 1999 1998 1997 1996 1995 1994 -------------- --------- --------- --------- --------- --------- Fixed charges $ 33,914 $ 332,985 $ 352,348 $ 283,974 $ 223,751 $ 139,188 Preferred stock dividends 5,684 22,342 25,457 36,356 39,334 38,876 --------- --------- --------- --------- --------- --------- Combined fixed charges and preferred stock dividends 39,598 355,327 377,805 320,330 263,085 178,064 Net income (loss) 13,907 (234,764) 159,926 127,228 77,359 85,579 --------- --------- --------- --------- --------- --------- Total $ 53,505 $ 120,563 $ 537,731 $ 447,558 $ 340,444 $ 263,643 ========= ========= ========= ========= ========= ========= Ratio of earnings to combined fixed charges and preferred stock dividends 1.35:1 0.34:1 1.42:1 1.40:1 1.29:1 1.48:1 ========= ========= ========= ========= ========= =========
EX-27 4 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CAPSTEAD MORTGAGE CORPORATION'S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED MARCH31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 8,025 0 0 0 0 0 0 0 9,510,807 4,820,512 4,001,716 0 197,099 587 490,893 9,510,807 0 127,550 0 0 2,212 0 111,431 13,907 0 13,907 0 0 0 13,907 0.14 0.14
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