<PAGE> 1
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
--- ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1998
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: 1-8896
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
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
<TABLE>
<CAPTION>
TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
------------------- ------------------------------------
<S> <C>
Common Stock ($0.01 par value) New York Stock Exchange
$1.60 Cumulative Preferred Stock, Series A ($0.10 par value) New York Stock Exchange
$1.26 Cumulative Convertible Preferred Stock, Series B ($0.10 par value) New York Stock Exchange
</TABLE>
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
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K: [ ]
AT MARCH 12, 1999 THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY
NONAFFILIATES WAS $299,295,354
NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AT MARCH 12, 1999: 59,866,520
DOCUMENTS INCORPORATED BY REFERENCE:
(1) PORTIONS OF THE REGISTRANT'S ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR
ENDED DECEMBER 31, 1998 ARE INCORPORATED BY REFERENCE INTO PARTS II AND IV.
(2) PORTIONS OF THE REGISTRANT'S DEFINITIVE PROXY STATEMENT, ISSUED IN
CONNECTION WITH THE 1999 ANNUAL MEETING OF STOCKHOLDERS OF THE REGISTRANT,
ARE INCORPORATED BY REFERENCE INTO PART III.
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<PAGE> 2
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I
ITEM 1. BUSINESS............................................................................ 1
ITEM 2. PROPERTIES.......................................................................... 2
ITEM 3. LEGAL PROCEEDINGS................................................................... 3
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................. 3
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS................................................... 3
ITEM 6. SELECTED FINANCIAL DATA............................................................. 3
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS............................................... 3
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................................... 3
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE............................................... 4
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................................. 4
ITEM 11. EXECUTIVE COMPENSATION.............................................................. 4
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT............................................................. 4
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................................... 4
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K............................................................... 4
</TABLE>
<PAGE> 3
PART I
ITEM 1. BUSINESS.
Capstead Mortgage Corporation ("CMC" or the "Company") was incorporated on April
15, 1985 in Maryland and commenced operations in September 1985. The Company's
business plan is to build a mortgage investment firm, earning income from
investing in mortgage assets on a leveraged basis and other investment
strategies.
Initially, the Company structured and managed mortgage investments. In late 1992
the Company entered into the mortgage servicing business. Mortgage servicing
includes collecting and accounting for payments of principal and interest from
borrowers, remitting such payments to investors, holding escrow funds for
payment of mortgage-related expenses such as taxes and insurance, making
advances to cover delinquent payments, inspecting the mortgage premises as
required, contacting delinquent mortgagors, supervising foreclosures and
property dispositions in the event of unremedied defaults, and generally
administering the loans. Fees are received for servicing residential mortgage
loans ranging generally from 0.25 to 0.38 percent per annum on the declining
principal balances of the loans and are collected out of monthly mortgage
payments. In December 1998 the Company sold its mortgage banking operations and
currently manages portfolios of high quality, single-family residential
mortgage-backed securities.
For further discussion of the Company's business, see the Registrant's Annual
Report to Stockholders for the year ended December 31, 1998 on pages 30 through
35.
EFFECTS OF INTEREST RATE CHANGES AND INTEREST RATE SENSITIVITY
For discussion of effects of interest rate changes on the Company's mortgage
securities portfolios, see the Registrant's Annual Report to Stockholders for
the year ended December 31, 1998 on pages 39 through 41.
OTHER INVESTMENT STRATEGIES
The Company may enter into other short- or long-term investment strategies as
the opportunities arise. With the December 1998 sale of its mortgage banking
operations, and reduced mortgage asset holdings, the Company entered 1999 with
substantial liquidity. The Company is evaluating a number of opportunities to
acquire or make 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.
COMPETITION
In purchasing mortgage securities, the Company competes with savings banks,
commercial banks, mortgage and investment bankers, conduits, insurance
companies, other lenders and mutual funds.
REGULATION AND RELATED MATTERS
Prior to its sale December 31, 1998, the Company's mortgage banking operations
were subject to the rules and regulations of FNMA and FHLMC with respect to
servicing and originating mortgage loans. In addition, there are other federal
and state statutes and regulations affecting such activities. Moreover, the
Company has been required to annually submit audited financial statements to
FNMA and FHLMC, and each regulatory entity has its own financial requirements.
The mortgage banking operation's affairs have also been subject to examination
by FNMA and FHLMC at all times to assure compliance with applicable regulations,
policies and procedures. Many of the aforementioned regulatory requirements are
designed to protect the interests of consumers, while others protect the owners
or insurers of mortgage loans. Failure to comply with these requirements can
lead to loss of approved status, termination of servicing contracts without
compensation to the servicer, demands for indemnification or loan repurchases,
class action lawsuits and administrative enforcement actions.
-1-
<PAGE> 4
EMPLOYEES
As of December 31, 1998, the Company had 22 full-time employees.
TAX STATUS
As used herein, "Capstead REIT" refers to CMC and the entities that are
consolidated with CMC for federal income tax purposes. Capstead REIT has elected
to be taxed as a REIT for federal income tax purposes and intends to continue to
do so. As a result of this election, Capstead REIT will not be taxed at the
corporate level on taxable income distributed to stockholders, provided that
certain requirements concerning the nature and composition of its income and
assets are met and that at least 95 percent of its REIT taxable income is
distributed.
If Capstead REIT fails to qualify as a REIT in any taxable year, it would be
subject to federal income tax at regular corporate rates and would not receive a
deduction for dividends paid to stockholders. If this were the case, the amount
of after-tax earnings available for distribution to stockholders would decrease
substantially.
As long as Capstead REIT qualifies as a REIT, it will generally be taxable only
on its undistributed taxable income. Distributions out of current or accumulated
earnings and profits will be taxed to stockholders as ordinary income or capital
gain, as the case may be. Distributions in excess of the Company's accumulated
and current earnings and profits will constitute a non-taxable return of capital
to the stockholders (except insofar as such distributions exceed the cost basis
of the shares of stock) resulting in a corresponding reduction in the cost basis
of the shares of stock. The Company notifies its stockholders of the proportion
of distributions made during the taxable year that constitutes ordinary income,
return of capital or capital gains. For 1998, no distributions were
characterized as capital gains due to capital losses realized on the sale of
mortgage assets this year. Capstead REIT has substantial capital loss
carryforwards that will in all likelihood eliminate the potential for capital
gain distributions through the year 2004 when remaining capital loss
carryforwards expire. During 1998, 92.0 percent and 8.0 percent of the common
stock distributions were characterized as ordinary income and nontaxable return
of capital, respectively, while 100 percent of the preferred stock distributions
were characterized as ordinary income. For 1997, capital gains were classified
as medium-term on sold assets that were held 12 to 18 months, and long-term on
sold assets that were held longer than 18 months. During 1997, 83.7 percent, 7.5
percent, 7.4 percent and 1.4 percent of the common stock distributions were
characterized as ordinary income, nontaxable return of capital, medium-term
capital gain and long-term capital gain, respectively, while 90.5 percent, 8.6
percent and 0.9 percent of the preferred stock distributions were characterized
as ordinary income, medium-term capital gain and long-term capital gain,
respectively. Distributions by the Company will not normally be eligible for the
dividends received deduction for corporations. Should the Company incur losses,
stockholders will not be entitled to include such losses in their individual
income tax returns.
All taxable income of Capstead Holdings, Inc., and its primary subsidiary
Capstead Inc. (which held the mortgage banking operations prior to their sale in
December 1998), is subject to federal and state income taxes, where applicable.
Capstead REIT's taxable income will include earnings of these subsidiaries only
upon payment to Capstead REIT by distribution of such earnings, and only if
these distributions are made out of current earnings and profits.
The foregoing is general in character. Reference should be made to pertinent
Internal Revenue Code sections and the Regulations issued thereunder for a
comprehensive statement of applicable federal income tax consequences.
ITEM 2. PROPERTIES.
The Company's operations are conducted in Dallas, Texas on properties leased by
the Company.
-2-
<PAGE> 5
ITEM 3. LEGAL PROCEEDINGS.
Between July 23, 1998 and November 11, 1998, twenty-four purported class action
lawsuits were filed against the Company and certain of its senior officers which
allege, 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.
All of the lawsuits are pending in the United States District Court for the
Northern District of Texas. In 23 of the lawsuits, the individual defendants
were Ronn K. Lytle, Christopher T. Gilson, Julie A. Moore, Andrew F. Jacobs and
William H. Rudluff. In one of the lawsuits, the individual defendants included
only Messrs. Lytle and Jacobs and Ms. Moore.
ITEM 4. RESULTS OF SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The information required by this item is included in the Registrant's Annual
Report to Stockholders for the year ended December 31, 1998 on page 28 under the
caption "Note 15 - Market and Dividend Information," and is incorporated herein
by reference, pursuant to General Instruction G(2).
ITEM 6. SELECTED FINANCIAL DATA.
The information required by this item is included in the Registrant's Annual
Report to Stockholders for the year ended December 31, 1998 on page 29 under the
caption "Selected Financial Data," and is incorporated herein by reference,
pursuant to General Instruction G(2).
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The information required by this item is included in the Registrant's Annual
Report to Stockholders for the year ended December 31, 1998 on pages 30 through
42 under the caption "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and is incorporated herein by reference,
pursuant to General Instruction G(2).
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item is included in the Registrant's Annual
Report to Stockholders for the year ended December 31, 1998 on pages 3 through
28, and is incorporated herein by reference, pursuant to General Instruction
G(2).
-3-
<PAGE> 6
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item is included in the Registrant's 1999
definitive Proxy Statement on pages 3 through 6 under the captions "Election of
Directors," "Board of Directors" and "Executive Officers," which is incorporated
herein by reference pursuant to General Instruction G(3).
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is included in the Registrant's 1999
definitive Proxy Statement on pages 7 through 14 under the captions "Executive
Compensation," "Compensation Committee Report on Executive Compensation," and
"Performance Graph," which is incorporated herein by reference pursuant to
General Instruction G(3).
ITEM 12. SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS.
The information required by this item is included in the Registrant's 1999
definitive Proxy Statement on pages 16 and 17 under the caption "Security
Ownership of Management and Certain Beneficial Owners," which is incorporated
herein by reference pursuant to General Instruction G(3).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report:
1. The following consolidated financial statements of the
Company, included in the 1998 Annual Report to Stockholders,
are incorporated herein by reference:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Statement of Operations -
Three Years Ended December 31, 1998........................................... *
Consolidated Balance Sheet - December 31, 1998 and 1997......................... *
Consolidated Statement of Stockholders' Equity -
Three Years Ended December 31, 1998........................................... *
Consolidated Statement of Cash Flows -
Three Years Ended December 31, 1998........................................... *
Notes to Consolidated Financial Statements - December 31, 1998.................. *
</TABLE>
NOTE: All schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission
are not required under the related instructions or are
inapplicable, and therefore have been omitted.
* Incorporated herein by reference from the Company's Annual
Report to Stockholders for the year ended December 31, 1998.
-4-
<PAGE> 7
PART IV
ITEM 14. -- CONTINUED
3. Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<S> <C>
1.3 Sales Agency Agreement dated as of December 6,
1995 between Capstead Mortgage Corporation and
PaineWebber Incorporated (the "Sales Agency
Agreement")(6)
1.4 Amendment No. 1 to the Sales Agency Agreement
dated as of September 10, 1996 between Capstead
Mortgage Corporation and PaineWebber Incorporated
(the "Common Stock Sales Agency Agreement")(8)
1.5 Sales Agency Agreement dated as of August 17, 1996
Capstead Mortgage Corporation and PaineWebber
Incorporated (the "Series B Preferred Stock 1996
Sales Agency Agreement")(8)
1.6 The Second Amendment dated as of March 4, 1997 to
the Sales Agency Agreement dated as of December 6,
1995 between the Company and PaineWebber
Incorporated (the "Common Stock Sales Agency
Agreement")(9)
1.7 The First Amendment dated as of March 4, 1997 to
the Sales Agency Agreement dated as of September
17, 1996 between the Company and PaineWebber
Incorporated (the "Series B Preferred Stock 1996
Sales Agency Agreement")(9)
1.8 The Third Amendment dated as of November 17, 1997
to the Sales Agency Agreement dated as of December
6, 1995 between the Company and PaineWebber
Incorporated (the "Sales Agency Agreement")(11)
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.(12)
3.1(a) Charter of the Company, which includes Articles of
Incorporation, Articles Supplementary for each
outstanding Series of Preferred Stock and all
other amendments to such Articles of
Incorporation(4)
3.1(b) Articles Supplementary ($1.26 Cumulative
Convertible Preferred Stock, Series B)(3)
3.2 Bylaws of the Company, as amended(4)
10.21 1990 Employee Stock Option Plan(1)
10.22 1990 Directors' Stock Option Plan(2) Employment
Agreement dated August 1, 1992 between Capstead
Mortgage Corporation
10.23 and Ronn K. Lytle(3)
10.24 Restricted Stock Grant Agreement dated August 1,
1992 between Capstead Mortgage Corporation and
Ronn K. Lytle(3)
10.25 1994 Flexible Long Term Incentive Plan(5)
10.26 1994 Capstead Inc. Restricted Stock Plan(5)
10.27 Capstead Mortgage Corporation Deferred
Compensation Plan(5)
10.28 Summary of Employment Agreement dated December 9,
1993 between Capstead Mortgage Corporation and
Christopher T. Gilson(5)
10.29 Capstead Mortgage Corporation Incentive Bonus
Plan(7)
10.30 Amendment to the 1994 Flexible Long Term Incentive
Plan(7)
10.31 Amendment No. 1 dated March 31, 1997 to the
Employment Agreement dated August 1, 1992 between
the Company and Ronn K. Lytle(10)
</TABLE>
-5-
<PAGE> 8
PART IV
ITEM 14. -- CONTINUED
3. Exhibits (continued):
<TABLE>
<CAPTION>
Exhibit
Number Item
------ ----
<S> <C>
10.32 1997 Flexible Long Term Incentive Plan(10)
10.33 Purchase and Sale Agreement dated as of November 30, 1998 by
and among Capstead Inc. and GMAC Mortgage Corporation(12)
11 Computation of per share earnings*
12 Computation of ratio of earnings to combined fixed charges and
preferred stock dividends*
13 Portions of the Annual Report to Stockholders of the Company
for the year ended December 31, 1998*
21 List of subsidiaries of the Company*
23 Consent of Ernst & Young LLP, Independent Auditors*
27 Financial Data Schedule (electronic filing only)*
</TABLE>
(1) Incorporated by reference to the Company's Registration Statement on
Form S-8 (No. 33-40016) dated April 29, 1991
(2) Incorporated by reference to the Company's Registration Statement on
Form S-8 (No. 33-40017) dated April 29, 1991
(3) Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 31, 1992
(4) Incorporated by reference to the Company's Registration Statement on
Form S-3 (No. 33-62212) dated May 6, 1993
(5) Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 31, 1994
(6) Incorporated by reference to the Company's Current Report of Form 8-K
dated December 6, 1995
(7) Incorporated by reference to the Company's 10-Q for the quarterly
period ended March 31, 1996
(8) Incorporated by reference to the Company's Current Report of Form 8-K
dated August 20, 1996
(9) Incorporated by reference to the Company's Current Report of Form 8-K
dated March 26, 1997
(10) Incorporated by reference to the Company's 10-Q for the quarterly
period ended March 31, 1997
(11) Incorporated by reference to the Company's Current Report of Form 8-K
dated December 23, 1997
(12) Incorporated by reference to the Company's Current Report of Form 8-K
dated December 31, 1998
* Filed herewith
(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.
(c) Exhibits - The response to this section of ITEM 14 is submitted as a
separate section of this report.
(d) Financial Statement Schedules - The response to this section of ITEM 14 is
submitted as a separate section of this report.
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<PAGE> 9
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
CAPSTEAD MORTGAGE CORPORATION
REGISTRANT
Date: March 29, 1999 By: /s/ ANDREW F. JACOBS
------------------------------
Andrew F. Jacobs
Executive Vice President - Finance,
Treasurer and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated below and on the dates indicated.
/s/ RONN K. LYTLE Chairman, Chief Executive March 29, 1999
- ------------------------- Officer and Director
(Ronn K. Lytle)
/s/ ANDREW F. JACOBS Executive Vice President - March 29, 1999
- ------------------------- Finance, Treasurer
(Andrew F. Jacobs) and Secretary
/s/ BEVIS LONGSTRETH Director March 29, 1999
- -------------------------
(Bevis Longstreth)
/s/ PAUL M. LOW Director March 29, 1999
- -------------------------
(Paul M. Low)
/s/ HARRIET E. MIERS Director March 29, 1999
- -------------------------
(Harriet E. Miers)
/s/ WILLIAM R. SMITH Director March 29, 1999
- -------------------------
(William R. Smith)
/s/ JOHN C. TOLLESON Director March 29, 1999
- -------------------------
(John C. Tolleson)
-7-
<PAGE> 10
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Item
------ ----
<S> <C>
1.3 Sales Agency Agreement dated as of December 6, 1995 between
Capstead Mortgage Corporation and PaineWebber Incorporated (the
"Sales Agency Agreement")(6)
1.4 Amendment No. 1 to the Sales Agency Agreement dated as of
September 10, 1996 between Capstead Mortgage Corporation and
PaineWebber Incorporated (the "Common Stock Sales Agency
Agreement")(8)
1.5 Sales Agency Agreement dated as of August 17, 1996 Capstead
Mortgage Corporation and PaineWebber Incorporated (the "Series B
Preferred Stock 1996 Sales Agency Agreement")(8)
1.6 The Second Amendment dated as of March 4, 1997 to the Sales
Agency Agreement dated as of December 6, 1995 between the Company
and PaineWebber Incorporated (the "Common Stock Sales Agency
Agreement")(9)
1.7 The First Amendment dated as of March 4, 1997 to the Sales Agency
Agreement dated as of September 17, 1996 between the Company and
PaineWebber Incorporated (the "Series B Preferred Stock 1996
Sales Agency Agreement")(9)
1.8 The Third Amendment dated as of November 17, 1997 to the Sales
Agency Agreement dated as of December 6, 1995 between the Company
and PaineWebber Incorporated (the "Sales Agency Agreement")(11)
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.(12)
3.1(a) Charter of the Company, which includes Articles of Incorporation,
Articles Supplementary for each outstanding Series of Preferred
Stock and all other amendments to such Articles of
Incorporation(4)
3.1(b) Articles Supplementary ($1.26 Cumulative Convertible Preferred
Stock, Series B)(3)
3.2 Bylaws of the Company, as amended(4)
10.21 1990 Employee Stock Option Plan(1)
10.22 1990 Directors' Stock Option Plan(2) Employment Agreement dated
August 1, 1992 between Capstead Mortgage Corporation
10.23 and Ronn K. Lytle(3)
10.24 Restricted Stock Grant Agreement dated August 1, 1992 between
Capstead Mortgage Corporation and Ronn K. Lytle(3)
10.25 1994 Flexible Long Term Incentive Plan(5)
10.26 1994 Capstead Inc. Restricted Stock Plan(5)
10.27 Capstead Mortgage Corporation Deferred Compensation Plan(5)
10.28 Summary of Employment Agreement dated December 9, 1993 between
Capstead Mortgage Corporation and Christopher T. Gilson(5)
10.29 Capstead Mortgage Corporation Incentive Bonus Plan(7)
10.30 Amendment to the 1994 Flexible Long Term Incentive Plan(7)
10.31 Amendment No. 1 dated March 31, 1997 to the Employment Agreement
dated August 1, 1992 between the Company and Ronn K. Lytle(10)
</TABLE>
<PAGE> 11
<TABLE>
<CAPTION>
Exhibit
Number Item
------ ----
<S> <C>
10.32 1997 Flexible Long Term Incentive Plan(10)
10.33 Purchase and Sale Agreement dated as of November 30, 1998 by and
among Capstead Inc. and GMAC Mortgage Corporation(12)
11 Computation of per share earnings*
12 Computation of ratio of earnings to combined fixed charges and
preferred stock dividends*
13 Portions of the Annual Report to Stockholders of the Company for
the year ended December 31, 1998*
21 List of subsidiaries of the Company*
23 Consent of Ernst & Young LLP, Independent Auditors*
27 Financial Data Schedule (electronic filing only)*
</TABLE>
(1) Incorporated by reference to the Company's Registration Statement on Form
S-8 (No. 33-40016) dated April 29, 1991
(2) Incorporated by reference to the Company's Registration Statement on Form
S-8 (No. 33-40017) dated April 29, 1991
(3) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1992
(4) Incorporated by reference to the Company's Registration Statement on Form
S-3 (No. 33-62212) dated May 6, 1993
(5) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1994
(6) Incorporated by reference to the Company's Current Report of Form 8-K dated
December 6, 1995
(7) Incorporated by reference to the Company's 10-Q for the quarterly period
ended March 31, 1996
(8) Incorporated by reference to the Company's Current Report of Form 8-K dated
August 20, 1996
(9) Incorporated by reference to the Company's Current Report of Form 8-K dated
March 26, 1997
(10) Incorporated by reference to the Company's 10-Q for the quarterly period
ended March 31, 1997
(11) Incorporated by reference to the Company's Current Report of Form 8-K dated
December 23, 1997
(12) Incorporated by reference to the Company's Current Report of Form 8-K dated
December 31, 1998
* Filed herewith
<PAGE> 1
EXHIBIT 11
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
COMPUTATION OF PER SHARE EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
BASIC:*
Average number of common shares
outstanding 60,948 51,257 38,317
========== ========== ==========
Net income (loss) $ (234,764) $ 159,926 $ 127,228
Less cash dividends paid on
convertible preferred stock:
Series A ($1.60 paid per share) (609) (683) (804)
Series B ($1.26 paid per share) (21,732) (24,774) (35,552)
---------- ---------- ----------
Net income available to common
stockholders $ (257,105) $ 134,469 $ 90,872
========== ========== ==========
Basic net income (loss) per common share $ (4.22) $ 2.62 $ 2.37
========== ========== ==========
DILUTED:**
Average number of common shares
outstanding 51,257 38,317
Assumed conversion of convertible
preferred stock:
Series A 889 1,048
Series B 14,776 21,176
Incremental shares calculated
using the treasury stock method 1,101 960
---------- ----------
38,023 61,501
========== ==========
Net income $ 159,926 $ 127,228
========== ==========
Diluted net income (loss) per common share $ (4.22) $ 2.35 $ 2.07
========== ========== ==========
</TABLE>
* Amounts for 1996 have been restated as required to comply with Statement of
Financial Accounting Standards No. 128, "Earnings Per Share." For further
discussion of net income (loss) per common share, see the notes to the
consolidated financial statements. Amounts have been adjusted for the
3-for-2 common stock split effective July 31, 1996.
** The Series A and B Preferred Stock was not considered convertible for
purposes of calculating diluted net loss per common share in 1998 because
the effects of conversion were antidilutive.
<PAGE> 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):
<TABLE>
<CAPTION>
Year Ended December 31
---------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Fixed charges $ 673,233 $ 633,845 $ 598,312 $ 584,137 $ 474,844
Preferred stock dividends 22,342 25,457 36,356 39,334 38,876
------------ ------------ ------------ ------------ ------------
Combined fixed charges and
preferred stock dividends 695,575 659,302 634,668 623,471 513,720
Net income (loss) (234,764) 159,926 127,228 77,359 85,579
------------ ------------ ------------ ------------ ------------
Total $ 460,811 $ 819,228 $ 761,896 $ 700,830 $ 599,299
============ ============ ============ ============ ============
Ratio of earnings to combined
fixed charges and preferred
stock dividends 0.66:1 1.24:1 1.20:1 1.12:1 1.17:1
</TABLE>
(b) Computation of ratio of earnings to combined fixed charges and preferred
stock dividends (excluding CMO debt):
<TABLE>
<CAPTION>
Year Ended December 31
---------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Fixed charges $ 332,985 $ 352,348 $ 283,974 $ 223,751 $ 139,188
Preferred stock dividends 22,342 25,457 36,356 39,334 38,876
------------ ------------ ------------ ------------ ------------
Combined fixed charges and
preferred stock dividends 355,327 377,805 320,330 263,085 178,064
Net income (loss) (234,764) 159,926 127,228 77,359 85,579
------------ ------------ ------------ ------------ ------------
Total $ 120,563 $ 537,731 $ 447,558 $ 340,444 $ 263,643
============ ============ ============ ============ ============
Ratio of earnings to combined
fixed charges and preferred
stock dividends 0.34:1 1.42:1 1.40:1 1.29:1 1.48:1
</TABLE>
<PAGE> 1
EXHIBIT 13
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
PORTIONS OF THE
ANNUAL REPORT TO STOCKHOLDERS
FOR THE YEAR ENDED DECEMBER 31, 1998
<PAGE> 2
REPORT OF INDEPENDENT AUDITORS
Stockholders and Board of Directors
Capstead Mortgage Corporation
We have audited the accompanying consolidated balance sheet of Capstead
Mortgage Corporation and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Capstead
Mortgage Corporation and subsidiaries at December 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
Dallas, Texas
February 4, 1999
<PAGE> 3
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31
---------------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
INTEREST INCOME:
Mortgage securities and other investments $ 311,807 $ 339,980 $ 303,212
CMO collateral and investments 355,391 354,279 359,752
--------- --------- ---------
Total interest income 667,198 694,259 662,964
INTEREST AND RELATED EXPENSE:
Short-term borrowings:
Mortgage securities and other investments 291,125 300,391 255,481
CMO investments 22,733 29,244 12,044
Collateralized mortgage obligations 340,248 281,497 314,338
Mortgage insurance and other 5,469 5,155 7,743
--------- --------- ---------
Total interest and related expense 659,575 616,287 589,606
--------- --------- ---------
Net margin on mortgage assets and other investments 7,623 77,972 73,358
--------- --------- ---------
MORTGAGE BANKING REVENUE 206,089 172,916 130,553
--------- --------- ---------
MORTGAGE SERVICING EXPENSE:
Servicing expense 28,679 25,889 20,187
Amortization and impairment of mortgage servicing rights
and related expense 319,886 64,892 44,795
Gain on financial instruments held to offset the effects of impairment (173,424) -- --
Interest 19,127 22,713 16,449
--------- --------- ---------
Total mortgage servicing expense 194,268 113,494 81,431
--------- --------- ---------
Net margin on mortgage banking operations 11,821 59,422 49,122
--------- --------- ---------
OTHER OPERATING REVENUE (EXPENSE):
Gain (loss) on sale of mortgage assets and related derivative
financial instruments (245,261) 27,737 15,991
Impairment on CMO investments (4,051) -- --
CMO administration and other 4,598 4,000 3,730
Other operating expense (9,494) (9,205) (14,973)
--------- --------- ---------
Total other operating revenue (expense) (254,208) 22,532 4,748
--------- --------- ---------
NET INCOME (LOSS) $(234,764) $ 159,926 $ 127,228
========= ========= =========
Net income (loss) $(234,764) $ 159,926 $ 127,228
Less cash dividends on preferred stock (22,342) (25,457) (36,356)
--------- --------- ---------
Net income available (loss attributable) to common stockholders $(257,106) $ 134,469 $ 90,872
========= ========= =========
NET INCOME (LOSS) PER COMMON SHARE:
Basic $ (4.22) $ 2.62 $ 2.37
Diluted (4.22) 2.35 2.07
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic 60,948 51,257 38,317
Diluted 60,948 68,023 61,501
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 4
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
December 31
------------------------------
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Mortgage securities and other investments $ 2,369,602 $ 6,114,130
CMO collateral and investments 4,571,274 5,195,436
------------ ------------
6,940,876 11,309,566
Mortgage servicing rights -- 669,062
Prepaids, receivables and other 59,526 361,510
Cash and cash equivalents 73,385 17,377
Restricted cash and cash equivalents 26,500 --
------------ ------------
$ 7,100,287 $ 12,357,515
============ ============
LIABILITIES
Short-term borrowings $ 1,839,868 $ 7,099,706
Collateralized mortgage obligations 4,521,324 4,309,455
Accounts payable and accrued expenses 58,894 59,746
------------ ------------
6,420,086 11,468,907
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value;
100,000 shares authorized:
$1.60 Cumulative Preferred Stock, Series A,
374 and 408 shares issued and outstanding
($6,134 aggregate liquidation preference) 5,228 5,698
$1.26 Cumulative Convertible Preferred Stock, Series B,
17,298 and 17,081 shares issued and outstanding
($196,851 aggregate liquidation preference) 193,196 189,800
Common stock - $0.01 par value; 100,000 shares authorized;
60,546 and 58,541 shares issued and outstanding 605 585
Paid-in capital 787,677 732,295
Undistributed income (loss) (305,287) 12,676
Accumulated other comprehensive income (loss) (1,218) (52,446)
------------ ------------
680,201 888,608
------------ ------------
$ 7,100,287 $ 12,357,515
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 5
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Years Ended December 31, 1998
------------------------------------------------------
Preferred Common Paid-in Undistributed
Stock Stock Capital Income (Loss)
--------- --------- --------- --------------
<S> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996 $ 337,750 $ 353 $ 321,222 $ (2,503)
Comprehensive income:
Net income -- -- -- 127,228
Other comprehensive income (loss):
Change in unrealized loss on debt
securities, net of reclassification amount -- -- -- --
Total comprehensive income
Cash dividends:
Common ($2.11 1/2 per share) -- -- -- (83,787)
Preferred:
Series A ($1.60 per share) -- -- -- (804)
Series B ($1.26 per share) -- -- -- (35,552)
Conversion of preferred stock (80,490) 54 80,412 --
Additions to capital 9,136 40 59,411 --
--------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1996 266,396 447 461,045 4,582
Comprehensive income:
Net income -- -- -- 159,926
Other comprehensive income (loss):
Change in unrealized loss on debt
securities, net of reclassification amount -- -- -- --
Total comprehensive income
Cash dividends:
Common ($2.40 per share) -- -- -- (126,375)
Preferred:
Series A ($1.60 per share) -- -- -- (683)
Series B ($1.26 per share) -- -- -- (24,774)
Conversion of preferred stock (85,097) 57 85,040 --
Additions to capital 14,199 81 186,210 --
--------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1997 195,498 585 732,295 12,676
Comprehensive loss:
Net loss -- -- -- (234,764)
Other comprehensive income (loss):
Change in unrealized loss on debt
securities, net of reclassification amount -- -- -- --
Total comprehensive loss
Cash dividends:
Common ($1.00 per share) -- -- -- (60,857)
Preferred:
Series A ($1.60 per share) -- -- -- (610)
Series B ($1.26 per share) -- -- -- (21,732)
Conversion of preferred stock (1,111) 1 1,110 --
Net additions to capital 4,037 19 54,272 --
--------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1998 $ 198,424 $ 605 $ 787,677 $(305,287)
========= ========= ========= =========
<CAPTION>
Three Years Ended December 31, 1998
-----------------------------------
Accumulated
Other
Comprehensive
Income (Loss) Total
-------------- ---------
<S> <C> <C>
BALANCE AT JANUARY 1, 1996 $ 7,902 $ 664,724
Comprehensive income:
Net income -- 127,228
Other comprehensive income (loss):
Change in unrealized loss on debt
securities, net of reclassification amount (13,503) (13,503)
---------
Total comprehensive income 113,725
Cash dividends:
Common ($2.11[OBJECT OMITTED] per share) -- (83,787)
Preferred:
Series A ($1.60 per share) -- (804)
Series B ($1.26 per share) -- (35,552)
Conversion of preferred stock -- (24)
Additions to capital -- 68,587
--------- ---------
BALANCE AT DECEMBER 31, 1996 (5,601) 726,869
Comprehensive income:
Net income -- 159,926
Other comprehensive income (loss):
Change in unrealized loss on debt
securities, net of reclassification amount (46,845) (46,845)
---------
Total comprehensive income 113,081
Cash dividends:
Common ($2.40 per share) -- (126,375)
Preferred:
Series A ($1.60 per share) -- (683)
Series B ($1.26 per share) -- (24,774)
Conversion of preferred stock -- --
Additions to capital -- 200,490
--------- ---------
BALANCE AT DECEMBER 31, 1997 (52,446) 888,608
Comprehensive loss:
Net loss -- (234,764)
Other comprehensive income (loss):
Change in unrealized loss on debt
securities, net of reclassification amount 51,228 51,228
---------
Total comprehensive loss (183,536)
Cash dividends:
Common ($1.00 per share) -- (60,857)
Preferred:
Series A ($1.60 per share) -- (610)
Series B ($1.26 per share) -- (21,732)
Conversion of preferred stock -- --
Net additions to capital -- 58,328
--------- ---------
BALANCE AT DECEMBER 31, 1998 $ (1,218) $ 680,201
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 6
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Year Ended December 31
---------------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ (234,764) $ 159,926 $ 127,228
Noncash items:
Impairment on CMO investments 4,051 -- --
Amortization and impairment of mortgage servicing rights
and related costs 319,886 64,892 44,795
Amortization of discount and premium 134,693 114,603 61,520
Depreciation and other amortization 5,010 3,585 3,670
Gain on sale of financial instruments held to offset the effects
of impairment of mortgage servicing rights (173,424) -- --
Gain on sale of mortgage servicing rights and mortgage
banking operations (2,877) -- --
Loss (gain) on sale of mortgage assets and related
derivative financial instruments 245,261 (27,737) (15,991)
Net change in prepaids, receivables, other assets, accounts
payable and accrued expenses 112,183 (26,994) 8,364
----------- ----------- -----------
Net cash provided by operating activities 410,019 288,275 229,586
----------- ----------- -----------
INVESTING ACTIVITIES:
Purchases of mortgage securities and other investments (4,797,684) (4,467,187) (1,813,735)
Purchases of CMO collateral and investments (1,305,865) (1,684,295) (521,539)
Purchases of mortgage servicing rights (106,498) (139,997) (251,505)
Purchases of derivative financial instruments (78,396) (112,417) (49,301)
Principal collections on mortgage investments 2,112,469 1,459,956 975,640
Proceeds from sales of mortgage assets 6,924,038 2,020,450 730,807
Proceeds from sales and settlement of derivative financial instruments 239,481 34,191 6,782
Proceeds from sale of mortgage servicing rights and mortgage
banking operations 582,772 -- --
CMO collateral:
Principal collections 1,187,988 537,817 552,430
Decrease in accrued interest receivable 8,367 4,724 5,119
Decrease (increase) in short-term investments 721 (4,546) 13,650
----------- ----------- -----------
Net cash provided (used) by investing activities 4,767,393 (2,351,304) (351,652)
----------- ----------- -----------
FINANCING ACTIVITIES:
Increase (decrease) in short-term borrowings (5,259,838) 1,636,850 834,074
Increase (decrease) in mortgage servicing acquisitions payable (8,363) (63,374) 23,899
Collateralized mortgage obligations:
Issuances of securities 1,494,853 1,109,411 41,323
Principal payments on securities (1,299,115) (673,119) (723,881)
Increase (decrease) in accrued interest payable (11,977) 2,253 1,383
Capital stock transactions 46,235 199,214 67,712
Dividends paid (83,199) (151,832) (120,143)
----------- ----------- -----------
Net cash provided (used) by financing activities (5,121,404) 2,059,403 124,367
----------- ----------- -----------
Net change in cash and cash equivalents 56,008 (3,626) 2,301
Cash and cash equivalents at beginning of year 17,377 21,003 18,702
----------- ----------- -----------
Cash and cash equivalents at end of year $ 73,385 $ 17,377 $ 21,003
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE> 7
CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
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. Declining long-term interest rates throughout much of 1998 kept
long-term interest rates at or below short-term interest rates for most of the
year. This unfavorable interest rate environment led to significantly higher
mortgage prepayment rates, which negatively impacted yields and asset valuations
on most of the Company's mortgage assets, particularly on the Company's mortgage
servicing and interest-only mortgage-backed securities portfolios. These market
conditions contributed to liquidity issues for the mortgage finance industry as
the availability of financing diminished for all but the highest quality
mortgage assets. In response to these market conditions, the Company reduced its
mortgage asset portfolios, which included the disposition of a large portfolio
of interest-only mortgage-backed securities at a substantial loss, and in
December 1998 completed the sale of its mortgage banking operations for a modest
gain (see NOTE 3 and 5).
The Company entered 1999 with substantial liquidity but diminished earning
capacity. In early 1999, the Company began to increase holdings of high quality
mortgage-backed securities and may continue to do so. The Company also announced
a common and preferred stock repurchase program (see NOTE 10), and that it is
evaluating a number of opportunities to acquire or make 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.
NOTE 2 -- ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Capstead
Mortgage Corporation ("Capstead"), its special-purpose finance subsidiaries and
certain other entities (collectively, the "Company"). Intercompany balances and
transactions have been eliminated. Substantially all of the assets of the
special-purpose finance subsidiaries are pledged to secure collateralized
mortgage obligations ("CMOs") and are not available for the satisfaction of
general claims of Capstead. Capstead has no responsibility for CMOs beyond the
assets pledged as collateral.
USE OF ESTIMATES
The use of estimates is inherent in the preparation of financial statements
in conformity with generally accepted accounting principles. The amortization of
premiums and discounts on mortgage assets and CMOs, as well as the amortization
of mortgage servicing rights (see NOTE 3), is based on estimates of future
movements in interest rates and of how resulting
8
<PAGE> 8
CAPSTEAD MORTGAGE CORPORATION
rates will impact prepayments on underlying mortgage loans. Actual results
could differ from those estimates. As was the case in 1998, prepayments could
rise to levels that could adversely affect profitability.
MORTGAGE ASSETS
Mortgage assets held in the form of mortgage-backed securities are debt
securities. Management determines the appropriate classification of debt
securities at the time of purchase and periodically reevaluates such
designation. Debt securities are classified as held-to-maturity when the Company
has the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at amortized cost. Debt securities not
classified as held-to-maturity are classified as available-for-sale.
Available-for-sale securities are stated at fair value with unrealized gains
(losses) reported as a separate component of Accumulated other comprehensive
income (loss) in stockholders' equity. Mortgage loans are carried at the lower
of cost or market determined on an aggregate basis.
Interest income is recorded as income when earned. Any premium or discount
is recognized as an adjustment to interest income by the interest method over
the life of the related mortgage asset. Realized gains (losses) are included in
Other operating revenue (expense). The cost of assets sold is based on the
specific identification method.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include unrestricted cash on hand and highly
liquid investments with original maturities of three months or less.
RESTRICTED CASH AND CASH EQUIVALENTS
Restricted cash and cash equivalents represents cash and highly liquid
investments held in escrow in connection with the sale of the mortgage banking
operations. These funds are scheduled to be released from escrow over an
18-month period ending July 1, 2000 provided the acquirers of the mortgage
banking operations have not made claims against these funds under the terms of
the related sale agreements (see NOTE 3).
MORTGAGE SERVICING RIGHTS
Prior to the December 1998 sale of the mortgage banking operations (see
NOTE 3), the cost of acquiring mortgage servicing rights was capitalized and
amortized in proportion to and over the period of estimated net servicing
income. Estimated net servicing income was evaluated periodically and
adjustments were made to the rate of amortization. Mortgage servicing rights
were evaluated for impairment on a disaggregated basis by predominant risk
characteristics. A valuation allowance was established through a charge to
operating results to the extent that the recorded amount for servicing rights
within an individual stratum exceeded fair value. Fair values were established
through use of a discounted cash flow valuation model that incorporated
assumptions the Company believed market participants used in estimating the fair
value of future net servicing income including assumptions regarding prepayment
speeds, discount rates and servicing costs. For impairment evaluation purposes,
the Company stratified its servicing portfolio based on term, interest rate and
loan type (fixed-rate versus adjustable-rate).
9
<PAGE> 9
CAPSTEAD MORTGAGE CORPORATION
DERIVATIVE FINANCIAL INSTRUMENTS
The Company may acquire derivative financial instruments ("Derivatives")
for risk management purposes. Derivatives acquired from time to time may include
interest rate floors and caps; U.S. Treasury futures contracts and options;
written options on mortgage assets or various other Derivatives available in the
market place that are compatible with the Company's risk management objectives.
Realized and unrealized gains (losses) on Derivatives not designated as hedges
are taken directly to operating results as a component of either Gain on
financial instruments held to offset the effects of impairment or Gain (loss) on
sale of mortgage assets and related derivative financial instruments. Realized
and unrealized gains (losses) on Derivatives designated as hedges reduce
(increase) the carrying amount of the assets hedged. Ongoing correlation and
effectiveness of such Derivatives are measured by comparing the change in value
of the hedges with the change in value of the assets hedged. Should a hedge
prove ineffective, hedge accounting would cease and the change in value of the
hedge instruments would be taken to operating results.
Prior to selling nearly all of its investments in interest-only mortgage
securities and its investment in mortgage servicing rights in June 1998 and
December 1998, respectively, the Company held interest rate floors to help
offset the effects of falling mortgage interest rates on the value of designated
portions of these investments. Beginning in July 1998, the Company supplemented
the floor positions with 10-year U.S. Treasury note futures contracts ("Treasury
Note Futures") to help mitigate the effects of further declines in mortgage
interest rates on the value of mortgage servicing rights (see NOTE 3 and 5).
Interest rate floors generally increase in value when interest rates decline.
Because interest rate floors are one-sided options, a holder of such instruments
has exposure to loss that is limited to the current basis in the instruments. A
holder may receive cash payments from counterparties should certain specified
interest rates fall below specified levels. Any such payments received by the
Company are accrued and taken directly to operating results as indicated above
or, for Derivatives designated as hedges, as a component of interest income on
CMO investments or amortization expense of mortgage servicing rights. Treasury
Note Futures generally increase in value when interest rates decline and
decrease in value when interest rates rise. Unlike interest rate floors,
Treasury Note Futures are two-sided options where the holder has unlimited
exposure to changes in interest rates and is subject to daily margin calls.
To a limited extent, the Company has used interest rate caps to partially
protect against rising interest rates on short-term borrowings. Interest rate
caps generally increase in value when interest rates rise. Like interest rate
floors, interest rate caps are one-sided options where the holder's exposure is
limited to the current basis in the instruments. A holder may receive cash
payments from counterparties should certain specific interest rates rise above
specified levels. Any such payments, if received by the Company, will be accrued
and taken to operating results, or for hedges, as a separate component of
interest expense on short-term borrowings.
The cost of acquiring Derivatives designated as hedges is taken as a charge
to operating results as a component of the related hedged item over the
contractual lives of these instruments. The fair value of Derivatives are
included in Prepaids, receivables and other on the balance sheet. The Company
has credit risk associated with the counterparties to Derivatives. The Company
manages credit risk by dealing only with large, financially sound investment
banking firms.
10
<PAGE> 10
CAPSTEAD MORTGAGE CORPORATION
BORROWINGS
CMOs and short-term borrowings are carried at their unpaid principal
balances, net of unamortized discount or premium. Any discount or premium is
recognized as an adjustment to interest expense by the interest method over the
expected term of the related borrowings.
MORTGAGE BANKING REVENUE
Prior to the December 1998 sale of the mortgage banking operations (see
NOTE 3), the Company earned mortgage banking revenue for servicing and, to a
lesser extent, originating single-family residential mortgage loans. Mortgage
banking revenue represents fees received for servicing mortgage loans, interest
earned on temporarily-held cash balances, income earned from originating and
selling mortgage loans and other ancillary income customary to mortgage banking
operations. Also included in mortgage banking revenue in 1998 is the gain on the
sale of this operation (see NOTE 3). Servicing fees were calculated based on a
contractual percentage of the outstanding monthly principal balance of mortgage
loans serviced and recognized as income when collected. Other mortgage revenue
was recorded on the accrual basis.
INCOME TAXES
Income taxes are accounted for using the liability method, and deferred
income tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using enacted tax rates and laws that will be in effect when the differences are
expected to reverse.
Capstead and its qualified real estate investment trust ("REIT")
subsidiaries have elected to be taxed as a REIT and intend to continue to do so.
As a result of this election, Capstead is not taxed on taxable income
distributed to stockholders if certain REIT qualification tests are met. It is
Capstead's policy to distribute 100 percent of taxable income of the REIT within
the time limits prescribed by the Internal Revenue Code (the "Code"), which may
extend into the subsequent taxable year. Accordingly, no provision has been made
for income taxes for Capstead and its qualified REIT subsidiaries. Capstead's
non-REIT subsidiaries file a separate consolidated federal income tax return and
are subject to income taxes.
STOCK-BASED COMPENSATION
Compensation cost for stock-based awards is generally measured as the
excess, if any, of the quoted market price of the Company's stock at the date of
the grant over the amount an employee must pay to acquire the stock and is
recognized as compensation expense as the awards vest and restrictions lapse.
NET INCOME (LOSS) PER COMMON SHARE
Basic net income (loss) per common share is computed by dividing net income
(loss), after deducting preferred stock dividends, by the weighted average
number of common shares outstanding after retroactively giving effect to stock
splits. Diluted net income (loss) per common share is computed by dividing net
income (loss) by the weighted average number of
11
<PAGE> 11
CAPSTEAD MORTGAGE CORPORATION
common shares and common stock equivalents outstanding, after retroactively
giving effect to stock splits, and assuming conversion of the $1.60 Cumulative
Preferred Stock, Series A ("Series A Preferred Stock") and the $1.26 Cumulative
Convertible Preferred Stock, Series B ("Series B Preferred Stock") if the
effects of conversion are dilutive. The Series A and B Preferred Stock was not
considered convertible for purposes of calculating diluted net loss per common
share in 1998 because the effects of conversion were antidilutive.
RECLASSIFICATION AND STOCK SPLITS
Certain amounts for prior years have been reclassified to conform to the
1998 presentation. On October 30, 1995 and July 31, 1996, the Company completed
3-for-2 common stock splits. The affected capital accounts as well as all
references to the number of common shares and share amounts in the accompanying
consolidated financial statements and related notes have been restated to
reflect the stock splits.
RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 1998 the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
establishes standards for the reporting of comprehensive income and its
components in financial statements. As the term currently relates to the
Company, comprehensive income (loss) consists of net income (loss) plus the
change in unrealized gain (loss) on debt securities classified as
available-for-sale (see NOTE 8). The adoption of SFAS 130 has not had any impact
on the results of operations or financial position of the Company.
In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for Derivatives and hedging activities. It requires that an
entity recognizes all Derivatives as either assets or liabilities in the
statement of financial position and measures those instruments at fair value. If
certain conditions are met, a Derivative may be specifically designated as (i) a
hedge of the exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment; (ii) a hedge of the exposure to
variable cash flows of a forecasted transaction; or (iii) in certain
circumstances, a hedge of a foreign currency exposure. This statement will
become effective for the Company's fiscal year ending December 31, 2000. The
adoption of SFAS 133 is not expected to have a material impact on the financial
position of the Company.
NOTE 3 -- SALE OF MORTGAGE BANKING OPERATIONS
On December 21, 1998 the Company's subsidiary Capstead Inc. closed the sale
of its investment in mortgage servicing rights to GMAC Mortgage Corporation
("GMACMC"), an affiliate of GMAC Mortgage Group, Inc., (a wholly-owned
subsidiary of General Motors Acceptance Corporation ("GMAC")). Under the terms
of the sale, the Company subserviced this mortgage servicing portfolio for
GMACMC for the month of December 1998. On December 31, 1998 Capstead Inc. closed
the sale of its mortgage banking operations to another GMAC affiliate,
Homecomings Financial Network, Inc. ("Homecomings"). A gain of $2.9 million on
these transactions was recorded as a component of Mortgage banking
12
<PAGE> 12
CAPSTEAD MORTGAGE CORPORATION
revenue. Homecomings is a wholly-owned subsidiary of Residential Funding
Corporation ("RFC"). Capstead Inc. has had a long-term subservicing
relationship with RFC, subservicing approximately $19 billion of RFC's
single-family mortgage loans just prior to the sale.
After retiring indebtedness related to the primary mortgage servicing
portfolio, related hedge instruments and loan production financing, and after
certain transaction costs, these transactions generated net cash proceeds of
approximately $500 million. Of these proceeds, $26.5 million is being held in
escrow for a period of up to 18 months to secure related indemnifications.
Pursuant to the servicing portfolio sale agreement, a prepayment protection
settlement payment of $16 million was remitted to GMACMC in February 1999. This
prepayment protection settlement was provided for in the determination of the
gain on these transactions, along with (i) other contract settlement provisions
(principally concerned with pricing adjustments on mortgage servicing rights
acquisition agreements and final settlement on operating assets acquired and
obligations assumed by the buyers), (ii) anticipated costs associated with
exiting the mortgage banking operations (see below), and (iii)
transaction-related expenses including costs associated with the acceleration of
benefits of restricted stock grants to employees (see NOTE 11).
In addition to the $16 million accrual for prepayment protection
settlement, included in Accounts payable and accrued expenses at December 31,
1998 is an accrual of approximately $7.2 million for other contract settlement
provisions and anticipated costs associated with mortgage servicing and mortgage
loan origination related contractual obligations incurred prior to the sale.
These costs include (i) completing trailing document work associated with the
primary mortgage servicing portfolio, (ii) completing payoff processing for
loans paid off prior to the sale, (iii) providing tax information to mortgagors
and vendors for calendar year 1998 and (iv) indemnifying GMACMC for costs of
mortgage loan buyback requests by investors in excess of existing
indemnifications by the originators of the loans. The Company is unaware of any
other material indemnification-related claims that may arise prior to the
release of the funds held in escrow.
13
<PAGE> 13
CAPSTEAD MORTGAGE CORPORATION
The following table provides information regarding the primary mortgage
servicing portfolio (which excludes subservicing) and the related investment in
mortgage servicing rights (dollars in thousands):
<TABLE>
<CAPTION>
Unpaid Mortgage
Principal Number Servicing
Balance of Loans Rights
------------ ------------ ------------
<S> <C> <C> <C>
Loans serviced at December 31, 1996 $ 35,562,597 366,373 $ 626,094
Additions 11,479,030 113,530 134,388
Results of hedging activity -- -- (33,387)
Runoff/amortization* (4,982,600) (38,626) (58,033)
------------ ------------ ------------
Loans serviced at December 31, 1997 42,059,027 441,277 669,062
Additions:
Purchases 4,409,143 37,877 91,640
Loan production 995,927 9,447 14,858
Runoff/amortization* (9,370,200) (80,584) (88,040)
Impairment reserve (see below) -- -- (224,733)
Results of hedging activity (see below) -- -- (1,141)
Sale of mortgage servicing portfolio (38,093,897) (408,017) (461,646)
------------ ------------ ------------
Loans serviced at December 31, 1998 $ -- -- $ --
============ ============ ============
</TABLE>
* Excludes related amortization expense associated with loan setup and
hedging activities.
During 1998 the Company recorded impairment charges totaling $224.7 million
reflecting the loss in value of its investment in mortgage servicing rights
caused by increasingly high rates of current and anticipated future mortgage
prepayments. Derivatives, specifically interest rate floors, were held to offset
the effects of falling mortgage interest rates on the value of a designated
portion of the servicing portfolio and were accorded hedge accounting treatment
through May of 1998. Early in 1998, and particularly in the second quarter,
these instruments under-performed relative to the loss in value of the servicing
rights they were intended to hedge due primarily to an overabundance of other
Derivatives in the marketplace, which effectively limited fair value increases
for the interest rate floors held by the Company. As a result, these Derivatives
no longer met hedge accounting criteria requiring high ongoing correlation and,
beginning in June 1998, changes in value of these instruments were included in
operating results rather than recorded as an adjustment to the carrying amount
of the servicing asset.
In response to unfavorable market conditions (see NOTE 1), in July 1998 the
Company began to actively manage an expanded portfolio of U.S. Treasury-based
financial instruments that included interest rate floors, Treasury Note Futures
and 10-year U.S. Treasury notes to help mitigate the effects of further declines
in mortgage interest rates on the value of the mortgage servicing rights.
Substantially all of these instruments were sold by year-end, including
approximately $80 million in interest rate floors and Treasury Note Futures
positions sold to GMACMC. During 1998 the Company realized gains of $119.5
million on interest rate floors and Treasury Note Futures and $53.9 million on
the sale of U.S. Treasury notes, net of related taxes of $1.6 million. These
gains are recorded as Gain on financial instruments held to offset the effects
of impairment of mortgage servicing rights.
Prior to the sale of the mortgage banking operations, the Company
maintained segregated escrow deposits that were held in bank trust accounts. At
December 31, 1997 escrow and
14
<PAGE> 14
CAPSTEAD MORTGAGE CORPORATION
fiduciary funds for loans serviced totaled $725 million, which were excluded
from the accompanying 1997 consolidated balance sheet.
NOTE 4 -- MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities and other investments and the related average effective
interest rates (calculated for the indicated year including mortgage insurance
costs on non-agency securities and excluding unrealized gains and losses) were
as follows (dollars in thousands):
<TABLE>
<CAPTION>
Principal Premium Cost Carrying
Balance (Discount) Basis Amount
------------- ------------- ------------- -------------
*
<S> <C> <C> <C> <C>
DECEMBER 31, 1998
Agency and U.S. Treasury
securities:
U.S. Treasury notes $ -- $ -- $ -- $ --
Fixed-rate 397,648 (731) 396,917 400,345
Medium-term 313,947 3,597 317,544 318,033
Adjustable-rate 1,487,582 30,985 1,518,567 1,509,807
Non-agency securities:
Fixed-rate 34,826 (11) 34,815 35,671
Medium-term -- -- -- --
Adjustable-rate -- -- -- --
Mortgage loans held
for sale*** 105,892 (146) 105,746 105,746
------------- ------------- ------------- -------------
$ 2,339,895 $ 33,694 $ 2,373,589 $ 2,369,602
============= ============= ============= =============
DECEMBER 31, 1997 Agency securities:
Fixed-rate $ 880,298 $ (4,370) $ 875,928 $ 871,377
Medium-term 607,858 7,502 615,360 616,992
Adjustable-rate 3,937,013 80,096 4,017,109 4,030,460
Non-agency securities:
Fixed-rate 81,608 467 82,075 82,954
Medium-term 346,961 441 347,402 347,772
Adjustable-rate 159,947 1,169 161,116 164,575
------------- ------------- ------------- -------------
$ 6,013,685 $ 85,305 $ 6,098,990 $ 6,114,130
============= ============= ============= =============
<CAPTION>
Average
Average Effective
Coupon Rate
------------- -------------
** **
<S> <C> <C>
DECEMBER 31, 1998
Agency and U.S. Treasury
securities:
U.S. Treasury notes --% 5.40%
Fixed-rate 6.50 6.51
Medium-term 6.60 5.94
Adjustable-rate 7.06 5.55
Non-agency securities:
Fixed-rate 8.57 7.86
Medium-term -- 6.29
Adjustable-rate -- 6.81
Mortgage loans held
for sale*** 6.77 6.78
DECEMBER 31, 1997 Agency securities:
Fixed-rate 6.51% 6.55%
Medium-term 6.67 6.34
Adjustable-rate 7.02 6.12
Non-agency securities:
Fixed-rate 8.67 8.59
Medium-term 6.78 6.58
Adjustable-rate 7.79 7.12
</TABLE>
* Includes mark-to-market, if applicable (see NOTE 8).
** Average Coupon is calculated as of the indicated balance sheet date.
Average Effective Rate is calculated for the year 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
15
<PAGE> 15
CAPSTEAD MORTGAGE CORPORATION
interest rates that adjust one time, approximately 5 years following
origination of the mortgage loan, based on a specified margin over Fannie Mae
yields for 30-year, fixed-rate commitments at the time of adjustment, or (iii)
fixed-rate mortgage securities that have expected weighted average lives of 5
years or 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, or (iii) 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 mortgage-backed securities
issued by government-sponsored entities, either Fannie Mae, Freddie Mac or
Ginnie Mae ("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 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
CMO collateral consists of (i) fixed-rate, medium-term and adjustable-rate
mortgage-backed securities collateralized by single-family residential mortgage
loans and (ii) related investments, both pledged to secure CMO borrowings
("Pledged CMO Collateral"). CMO investments have included investments in Agency
Trust interest-only mortgage securities and investments in other CMO securities
such as other agency and private-issue interest-only and principal-only mortgage
securities. Agency Trust interest-only mortgage securities are entitled to
receive 100 percent of coupon interest stripped from pools of Agency Securities.
The components of CMO collateral and investments are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
December 31
-------------------------
1998 1997
---------- ----------
<S> <C> <C>
Pledged CMO Collateral:
Pledged mortgage securities $4,507,337 $4,326,696
Short-term investments 14,879 15,600
Accrued interest receivable 27,361 26,760
---------- ----------
4,549,577 4,369,056
Unamortized premium 11,830 2,752
---------- ----------
4,561,407 4,371,808
CMO investments:
Agency Trust interest-only mortgage securities -- 809,757
Other CMO investments 9,867 13,871
---------- ----------
$4,571,274 $5,195,436
========== ==========
</TABLE>
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
16
<PAGE> 16
CAPSTEAD MORTGAGE CORPORATION
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 $1.3 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 7.27 percent and
7.38 percent during 1998 and 1997, respectively.
The value of interest-only mortgage securities, which trade in a market
with relatively few participants, was significantly depressed in 1998 by
increasingly high rates of current and anticipated future mortgage prepayments
and sales of such securities by a number of large market participants. Late in
the second quarter of 1998, the Company committed to the sale of its entire $1.0
billion Agency Trust interest-only mortgage securities portfolio at a loss of
$251.9 million, net of related gains on Derivatives, and during the third
quarter of 1998 the Company wrote down to fair value its remaining investment in
interest-only mortgage securities through an other-than-temporary impairment
charge of $4.1 million. Derivatives, specifically interest rate floors, were
held to help offset the effects of falling mortgage interest rates on the value
of interest-only mortgage securities and were accorded hedge accounting
treatment through March of 1998. Early in 1998, and particularly in the second
quarter, these instruments under-performed relative to the loss in value of the
assets they were intended to hedge due primarily to an overabundance of other
Derivatives in the marketplace, which effectively limited fair value increases
for the interest rate floors held by the Company. As a result, these Derivatives
no longer met hedge accounting criteria requiring high ongoing correlation and,
beginning in April 1998, changes in value of these instruments were included in
operating results rather than recorded as an adjustment to the carrying amount
of the hedged assets. Such changes in value totaled $28.3 million during the
second quarter of 1998 prior to the sale of the Agency Trust interest-only
mortgage securities portfolio and are included in Gain (loss) from sale of
mortgage assets and related derivative financial instruments.
NOTE 6 -- SHORT-TERM BORROWINGS
Short-term borrowings are primarily made under uncommitted repurchase
arrangements with investment banking firms pursuant to which the Company pledges
mortgage assets as collateral. The terms and conditions of these arrangements,
including interest rates, are negotiated on a transaction-by-transaction basis.
17
<PAGE> 17
CAPSTEAD MORTGAGE CORPORATION
Repurchase arrangements, all of which had maturities of less than 31 days,
and the related average effective interest rates are classified by type of
collateral as follows (dollars in thousands):
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
------------------------------- ------------------------------
Weighted Weighted
Borrowings Average Borrowings Average
Outstanding Rate Outstanding Rate
----------- -------- ----------- --------
<S> <C> <C> <C> <C>
Agency Securities $ 1,839,868 5.47% $ 5,419,261 5.84%
Non-agency Securities -- -- 582,823 6.12
CMO investments -- -- 870,816 5.98
------------- -------------
$ 1,839,868 $ 6,872,900
============= =============
</TABLE>
With the December 1998 sale of the mortgage banking operations, Capstead
Inc. canceled its revolving line of credit agreement with an investment banking
firm that was secured by mortgage servicing rights. Interest rates on borrowings
under this facility were based on LIBOR with interest due monthly. At December
31, 1997, borrowings under this facility totaled $179,600,000 at 7.50 percent.
In addition, the Company borrowed against Derivative positions on an overnight
basis from the counterparties to these instruments. Borrowings under such
arrangements totaled $47,206,000 at a weighted average rate of 5.90 percent at
December 31, 1997.
The weighted average effective interest rate on short-term borrowings
secured by mortgage assets was 5.55 percent and 5.53 percent during 1998 and
1997, respectively. Interest paid on short-term borrowings totaled $347,633,000,
$339,077,000 and $279,160,000 during 1998, 1997 and 1996, respectively. As of
December 31, 1998, $1.9 billion of Agency Securities were pledged as collateral
under repurchase arrangements.
NOTE 7 -- 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):
<TABLE>
<CAPTION>
December 31
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
CMOs $ 4,513,522 $ 4,332,409
Accrued interest payable 25,609 28,417
----------- -----------
Total obligation 4,539,131 4,360,826
Unamortized discount (17,807) (51,371)
----------- -----------
$ 4,521,324 $ 4,309,455
=========== ===========
Range of average interest rates 5.22% to 9.45% 5.60% to 9.95%
Range of stated maturities 2007 to 2028 2007 to 2027
Number of series 31 33
</TABLE>
18
<PAGE> 18
CAPSTEAD MORTGAGE CORPORATION
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 7.85 percent and 7.63 percent during 1998 and 1997, respectively.
Interest paid on CMOs totaled $352,627,000, $263,151,000 and $304,670,000 during
1998, 1997 and 1996, respectively.
NOTE 8 -- DISCLOSURES REGARDING FAIR VALUES
OF FINANCIAL INSTRUMENTS
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 carrying amounts of cash and cash equivalents, receivables, payables
and short-term borrowings approximate fair value. The fair value of Agency and
U.S. Treasury Securities, Non-agency Securities (excluding mortgage loans held
for sale), CMO investments and Derivatives 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
fair value of CMOs was based on the same method used for determining fair value
for Pledged CMO collateral adjusted for credit enhancements. 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. The following table summarizes fair value
disclosures for financial instruments (in thousands):
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
------------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
ASSETS:
Cash and cash equivalents $ 73,385 $ 73,385 $ 17,377 $ 17,377
Restricted cash and cash equivalents 26,500 26,500 -- --
Receivables 41,717 41,717 120,542 120,542
Mortgage investments 2,263,856 2,263,856 6,114,130 6,115,048
CMO collateral and investments 4,571,274 4,641,641 5,195,436 5,253,299
Derivatives* 12,618 12,618 207,343 203,375
LIABILITIES:
Payables 58,894 58,894 59,746 59,746
Short-term borrowings 1,839,868 1,839,868 7,099,706 7,099,706
CMOs 4,521,324 4,614,764 4,309,455 4,413,285
</TABLE>
* Average fair values of Derivatives held by the Company and not accorded
hedge accounting treatment during 1998 and 1997 were $81.1 million and $2.9
million, respectively.
19
<PAGE> 19
CAPSTEAD MORTGAGE CORPORATION
The following table summarizes fair value disclosures for
available-for-sale debt securities (in thousands):
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
AS OF DECEMBER 31, 1998
Mortgage investments:
Agency Securities:
Fixed-rate $ 396,917 $ 3,466 $ 38 $ 400,345
Medium-term 317,544 862 373 318,033
Adjustable-rate 1,518,567 1,486 10,246 1,509,807
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
========== ========== ========== ==========
AS OF DECEMBER 31, 1997
Mortgage investments:
Agency Securities:
Fixed-rate $ 875,928 $ 2,903 $ 7,454 $ 871,377
Medium-term 615,360 1,678 46 616,992
Adjustable-rate 4,017,109 19,850 6,499 4,030,460
Non-agency Securities:
Fixed-rate 39,416 878 -- 40,294
Medium-term 222,054 398 28 222,424
Adjustable-rate 161,116 3,459 -- 164,575
CMO collateral and investments 891,213 332 67,917 823,628
---------- ---------- ---------- ----------
$6,822,196 $ 29,498 $ 81,944 $6,769,750
========== ========== ========== ==========
</TABLE>
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):
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
AS OF DECEMBER 31, 1998
Pledged CMO Collateral $4,377,589 $ 3,286 $ 26,359 $4,354,516
========== ========== ========== ==========
AS OF DECEMBER 31, 1997
Pledged CMO Collateral $4,371,808 $ 2,988 $ 48,955 $4,325,841
Non-agency Securities 168,008 918 -- 168,926
---------- ---------- ---------- ----------
$4,539,816 $ 3,906 $ 48,955 $4,494,767
========== ========== ========== ==========
</TABLE>
20
<PAGE> 20
CAPSTEAD MORTGAGE CORPORATION
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 the disposition of debt
securities (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Sale of securities held available-for-sale:
Amortized cost $ 6,233,622 $ 1,920,097 $ 624,151
Gains (losses)* (223,959) 24,043 13,936
Redemption of callable agency notes and sale of released CMO collateral
held-to-maturity:
Amortized cost 5,022 73,324 64,753
Gains 471 2,986 1,098
</TABLE>
* Represents the reclassification amounts included in other comprehensive
income (loss) as a component of the change in unrealized gains (losses) on
debt securities held available-for-sale.
NOTE 9 -- INCOME TAXES
Capstead and its qualified REIT subsidiaries file a separate federal income
tax return that does not include the operations of the non-REIT subsidiaries.
Provided all taxable income of Capstead and its qualified REIT subsidiaries is
distributed to stockholders within time limits prescribed by the Code, no income
taxes are due on this income. Taxable income of the non-REIT subsidiaries is
fully taxable. Income taxes paid during 1998 totaled $1,600,000. No income taxes
were paid during 1997 or 1996. Effective tax rates will differ substantially
from statutory federal income tax rates because of the effect of the following
items (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Income taxes computed at the federal statutory rate $(82,167) $ 55,974 $ 44,530
Nondeductible capital loss 83,651 -- --
Benefit of REIT status (3,650) (46,893) (35,384)
-------- -------- --------
Income taxes computed on income of non-REIT subsidiaries (2,166) 9,081 9,146
Benefit of previously unrecognized deferred income tax asset (667) (10,889) (8,308)
Tax effect of capital contributions to non-REIT subsidiaries 3,783 -- --
Other 650 1,808 (838)
-------- -------- --------
$ 1,600* $ -- $ --
======== ======== ========
</TABLE>
* The 1998 provision for income taxes is reflected in the statement of
operations as an offset to gains realized on financial instruments held to
offset the effects of impairment of mortgage servicing rights.
21
<PAGE> 21
CAPSTEAD MORTGAGE CORPORATION
Significant components of deferred income tax assets and liabilities are
as follows (in thousands):
<TABLE>
<CAPTION>
December 31
-------------------
1998 1997
------- -------
<S> <C> <C>
Deferred income tax assets:
Alternative minimum tax credit $ 1,915 $ 313
Net operating loss carryforwards -- 31,762
Hedging transactions -- 6,660
Other 864 1,630
------- -------
2,779 40,365
------- -------
Deferred income tax liabilities:
Mortgage servicing rights -- 37,276
Other 357 --
------- -------
357 37,276
------- -------
Net deferred tax assets $ 2,422 $ 3,089
======= =======
Valuation allowance $ 2,422 $ 3,089
======= =======
</TABLE>
At December 31, 1998 Capstead and its qualified REIT subsidiaries had
capital loss carryforwards for tax purposes of approximately $243 million, which
expire in the year 2004. At December 31, 1998 the non-REIT subsidiaries had net
operating loss carryforwards for tax purposes of approximately $5 million, which
expire in the year 2013.
NOTE 10 -- STOCKHOLDERS' EQUITY
The Series A Preferred Stock is entitled to a cumulative fixed dividend at
an annual rate of $1.60, is eligible for conversion into 2.1707 shares of common
stock and is nonvoting. The Series A Preferred Stock is currently redeemable at
the Company's option at a redemption price of $16.40 per share and has a
liquidation preference of $16.40 per share. During 1998, 33,682 shares of the
Series A Preferred Stock were converted into 69,124 shares of common stock.
The Series B Preferred Stock is entitled to a cumulative fixed dividend at
an annual rate of $1.26, is eligible for conversion into 0.7537 of 1 share of
common stock and is nonvoting. The Series B Preferred Stock is currently
redeemable at the Company's option at a redemption price of $12.50 per share and
has a liquidation preference of $11.38 per share. During 1998, 57,512 shares of
the Series B Preferred Stock were converted into 41,657 shares of common stock.
The weighted average shares used to calculate diluted net income per common
share in 1997 and 1996 differs from weighted average common shares outstanding
because of the dilutive effects of stock options and the potential conversion of
preferred stock into common stock in those years. In 1998 stock options and
preferred share conversions were anti-dilutive in calculating net loss per
common share; therefore, diluted net loss per common share was the same as basic
net loss per common share. Dilutive options increased weighted average shares by
1,101,000 and 960,000 shares in 1997 and 1996, respectively. The assumed
conversion of the Series A and B Preferred Stock increased weighted average
shares by 15,665,000 and 22,224,000 shares during 1997 and 1996, respectively.
22
<PAGE> 22
CAPSTEAD MORTGAGE CORPORATION
On February 4, 1999 the Board of Directors authorized the repurchase of up
to 6 million shares of its common stock and up to 2 million shares of its Series
B Preferred Stock. This program calls for the repurchase of shares in open
market transactions from time to time subject to the price of its securities and
alternative investment opportunities. 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.
Through May 1998 the Company used several programs designed to raise new
equity capital at favorable prices. These programs were indefinitely suspended
when the prices of the Company's equity issues declined during the second
quarter of 1998. The following tables summarize capital raised through these
programs (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------------------------- ------------------------- -------------------------
Net Net Net
Shares Proceeds Shares Proceeds Shares Proceeds
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
COMMON STOCK:
Dividend reinvestments 149,267 $ 2,901 810,791 $ 18,195 413,030 $ 8,326
Direct stock purchases 426,458 8,155 2,565,434 63,121 647,289 12,091
Structured equity shelf 1,751,500 33,349 4,108,900 97,938 1,954,550 37,443
---------- ---------- ---------- ---------- ---------- ----------
2,327,225 44,405 7,485,125 179,254 3,014,869 57,860
========= ---------- ========== ---------- ========== ----------
SERIES B PREFERRED STOCK:
Dividend reinvestments 74,376 1,085 185,523 3,120 310,434 4,259
Structured equity shelf 199,600 2,952 646,500 11,079 309,200 4,877
---------- ---------- ---------- ---------- ---------- ----------
273,976 4,037 832,023 14,199 619,634 9,136
========== ---------- ========== ---------- ========== ----------
$ 48,442 $ 193,453 $ 66,996
========== ========== ==========
</TABLE>
Dividend reinvestments allow existing stockholders to convert cash
dividends into newly issued shares. Similarly, direct stock purchases allow
investors the opportunity to acquire additional shares directly from the
Company, subject to certain limitations. Structured equity shelf issuances
represent new shares issued by the Company on a daily basis either directly into
the market or in larger blocks to qualified buyers, subject to certain
limitations.
Option exercises by employees during 1998, 1997 and 1996 resulted in net
additions to capital of $1,897,000, $5,761,000 and $7,246,000, respectively.
The Company's Charter provides that if the Board of Directors determines in
good faith that the direct or indirect ownership of stock of Capstead has become
concentrated to an extent which would cause Capstead to fail to qualify as a
REIT, the Company may redeem or repurchase, at fair market value, any number of
shares of common stock and/or preferred stock sufficient to maintain or bring
such ownership into conformity with the Code. In addition, the Company may
refuse to transfer or issue shares of common stock and/or preferred stock to any
person whose acquisition would result in Capstead being unable to comply with
the requirements of the Code. Finally, the Charter provides that the Company may
redeem or refuse to transfer any shares of capital stock of Capstead necessary
to prevent the imposition of a penalty tax as a result of ownership of such
shares by certain disqualified organizations, including governmental bodies and
tax-exempt entities that are not subject to tax on unrelated business taxable
income.
23
<PAGE> 23
CAPSTEAD MORTGAGE CORPORATION
NOTE 11 -- EMPLOYEE BENEFIT PLANS
The Company sponsors stock plans for directors and employees to provide for
the issuance of stock options and other incentive-based stock awards
(collectively, the "Plans"). The Plans provide for the issuance of up to an
aggregate of 7,512,500 shares of common stock. Options granted have terms and
vesting requirements at the grant date of up to ten years. Prior to a
restructuring of long-term incentive compensation for key officers on January 2,
1998 which eliminated this feature, most of the outstanding stock options
provided for the annual granting of dividend equivalent rights ("DERs") that
permitted the option holder to obtain additional shares of common stock based
upon formulas set forth in the Plans. The following table provides information
regarding stock option activity for the periods indicated:
<TABLE>
<CAPTION>
Number of Weighted Average
Shares Exercise Price
--------- ----------------
<S> <C> <C>
As of December 31, 1995 (1,293,221 exercisable) 2,059,423 $ 12.41
Granted (average fair value: $2.03 per share) 821,250 15.42
Exercised (563,230) 12.23
Canceled (17,559) 12.01
DERs granted (average fair value: $15.25 per share) 70,686 --
----------
As of December 31, 1996 (1,716,334 exercisable) 2,370,570 13.12
Granted (average fair value: $3.07 per share) 622,250 23.51
Exercised (431,568) 11.00
Canceled (1,125) 12.00
DERs granted (average fair value: $24.00 per share) 188,328 --
----------
As of December 31, 1997 (1,878,421 exercisable) 2,748,455 14.91
Granted (average fair value: $1.48 per share) 1,814,250 20.00
Exercised (161,546) 11.75
Canceled (690,127) 6.97
DERs granted (average fair value: $20.00 per share) 237,743 --
----------
As of December 31, 1998 (3,948,775 exercisable)* 3,948,775 17.87
==========
</TABLE>
* With the December 1998 sale of the mortgage banking operations, all
outstanding stock option awards became 100 percent vested. On June 30,
1999 unexercised options held by former employees of Capstead Inc.
(totaling 2,080,072 shares as of December 31, 1998) will be forfeited
under the terms of the Plans.
Weighted average exercise price and remaining life information for
significant option grants outstanding at December 31, 1998 were as follows:
<TABLE>
<CAPTION>
Weighted
Average
Options Options Exercise Remaining
Outstanding Exercisable Price Life (Years)
----------- ----------- -------- ------------
<S> <C> <C> <C> <C>
Options granted January 1998 1,648,232 1,648,232 $ 19.92 9
Options granted January 1997 582,147 582,147 23.35 8
Options granted January 1996 752,061 752,061 15.37 7
Options granted April 1994 854,015 854,015 12.83 5
</TABLE>
24
<PAGE> 24
CAPSTEAD MORTGAGE CORPORATION
In connection with the January 2, 1998 restructuring of long-term incentive
compensation for key officers, the Company canceled existing DER option grants
totaling 452,627 shares and eliminated the right to receive future DER award
grants in exchange for cash settlements aggregating $10,524,000 and 452,627
shares of restricted common stock. The cash settlements were fully accrued for
at December 31, 1997. The restricted stock had a grant date fair value of $20
per share and was granted subject to certain restrictions, including continuous
employment, which generally lapsed over 5 years.
During 1998 the Company also issued restricted stock grants for an
aggregate of 35,000 shares of common stock to employees completing their first
year of employment with the Company at grant date fair values averaging $11.18
per share. These grants were subject to certain restrictions, including
continuous employment, which generally lapsed over 10 years. Similar grants to
all qualifying employees were made in 1997 and 1996 for 201,000 and 144,000
shares of common stock at grant date fair values averaging $24.35 and $21.50 per
share, respectively. Additionally, in 1996 the Company issued restricted stock
grants for 262,500 shares of common stock to key officers at a grant date fair
value of $15.42 per share, also subject to restrictions as to continuous
employment which generally lapsed over 4 years from the date of grant.
Costs associated with restricted stock grants (generally measured by the
fair value of the Company's common stock on the date of grant multiplied by the
number of shares granted) have been recognized as compensation expense over the
period restricted. However, with the December 1998 sale of the mortgage banking
operations, all remaining restrictions lapsed under the terms of the Plans.
Therefore, the gain on sale of the mortgage banking operations includes a
$11,043,000 charge to eliminate all deferred compensation related to restricted
stock grants.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," and related Interpretations in accounting for
stock awards. Accordingly, no compensation expense has been recognized for stock
awards other than for DERs and restricted stock grants. Related compensation
costs, excluding the charge mentioned above, totaled $2,398,000, $6,323,000 and
$6,032,000 in 1998, 1997 and 1996, respectively. The effect of determining
compensation cost for stock options granted since the beginning of 1995, based
upon the estimated fair value at the grant date consistent with the methodology
prescribed under Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," would have been 3 cents per share or
less on diluted net income (loss) per common share for each of the last 3 years.
This effect on diluted net income (loss) per common share was determined using a
Black-Scholes option pricing model and, depending upon each individual option
grant during the last three years, dividend yields of 10 to 12 percent,
volatility factors of 27.8 to 32.5 percent, expected life assumptions of 3 to 5
years and risk-free rates of 5 percent to over 7 percent. This effect may not be
representative of the pro forma effect on future operating results.
The Company also sponsors a qualified defined contribution retirement plan
for all employees. The Company matches up to 50 percent of a participant's
voluntary contribution up to a maximum of 6 percent of a participant's
compensation and may make additional contributions of up to another 3 percent of
a participant's compensation. All Company contributions are subject to certain
vesting requirements. Contribution expenses were $709,000, $634,000 and $677,000
in 1998, 1997 and 1996, respectively.
25
<PAGE> 25
CAPSTEAD MORTGAGE CORPORATION
NOTE 12 -- 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.
NOTE 13 -- NET INTEREST INCOME ANALYSIS (UNAUDITED)
The following table summarizes interest income and interest expense and
average effective interest rates for the periods indicated (dollars in
thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------- -------------------------- -------------------------
Average Average Average
Amount Rate Amount Rate Amount Rate
---------- --------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Mortgage securities and other
investments $311,807 5.89% $339,980 6.28% $303,212 6.41%
CMO collateral and investments 355,391 7.28 354,279 7.84 359,752 7.73
-------- -------- --------
Total interest income 667,198 694,259 662,964
-------- -------- --------
Interest expense:
Short-term borrowings 313,858 5.55 329,635 5.53 267,525 5.53
CMOs 340,248 7.85 281,497 7.63 314,338 7.53
-------- -------- --------
Total interest expense 654,106 611,132 581,863
-------- -------- --------
Net interest $ 13,092 $ 83,127 $ 81,101
======== ======== ========
</TABLE>
The following tables summarize the changes in interest income and interest
expense due to changes in interest rates versus changes in volume for the
periods indicated (in thousands):
<TABLE>
<CAPTION>
1998/1997*
------------------------------------
Rate Volume Total
-------- -------- --------
<S> <C> <C> <C>
Interest income:
Mortgage securities and other investments $(20,988) $ (7,185) $(28,173)
CMO collateral and investments (26,168) 27,280 1,112
-------- -------- --------
Total interest income (47,156) 20,095 (27,061)
-------- -------- --------
Interest expense:
Short-term borrowings 1,010 (16,787) (15,777)
CMOs 8,591 50,160 58,751
-------- -------- --------
Total interest expense 9,601 33,373 42,974
-------- -------- --------
Net interest $(56,757) $(13,278) $(70,035)
======== ======== ========
</TABLE>
26
<PAGE> 26
CAPSTEAD MORTGAGE CORPORATION
<TABLE>
<CAPTION>
1997/1996*
------------------------------------
Rate Volume Total
-------- -------- --------
<S> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ (6,163) $ 42,931 $ 36,768
CMO collateral and investments 5,117 (10,590) (5,473)
-------- -------- --------
Total interest income (1,046) 32,341 31,295
-------- -------- --------
Interest expense:
Short-term borrowings -- 62,110 62,110
CMOs 4,002 (36,843) (32,841)
-------- -------- --------
Total interest expense 4,002 25,267 29,269
-------- -------- --------
Net interest $ (5,048) $ 7,074 $ 2,026
======== ======== ========
</TABLE>
* The change in interest due to both volume and rate has been allocated
to volume and rate changes in proportion to the relationship of the
absolute dollar amounts of the change in each.
NOTE 14 -- QUARTERLY RESULTS (UNAUDITED)
The following is a summary of quarterly results of operations (in
thousands, except percentages and per share amounts). See NOTE 1 for discussion
of significant changes to the Company's operations during 1998 that have
impacted 1998 quarterly operating results and are expected to impact future
operations.
<TABLE>
<CAPTION>
Year Ended December 31, 1998
--------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Interest income $ 193,019 $ 201,871 $ 144,683 $ 127,625
Interest and related expenses 178,652 191,358 162,891 126,674
--------- --------- --------- ---------
Net margin on mortgage assets and other
investments 14,367 10,513 (18,208) 951
Net margin on mortgage banking operations 14,845 (27,153) 13,215 10,914
Other operating revenue (expense) 5,858 (251,492) (6,832) (1,742)
--------- --------- --------- ---------
Net income (loss) $ 35,070 $(268,132) $ (11,825) $ 10,123
========= ========= ========= =========
Net income (loss) per common share:
Basic 0.50 (4.47) (0.28) 0.07
Diluted 0.48 (4.47) (0.28) 0.07
Return on average stockholders' equity 14.59% (117.53%) (7.00%) 5.97%
<CAPTION>
Year Ended December 31, 1997
--------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Interest income $165,281 $163,015 $175,915 $190,048
Interest and related expenses 143,015 142,902 154,865 175,505
-------- -------- -------- --------
Net margin on mortgage assets and other
investments 22,266 20,113 21,050 14,543
Net margin on mortgage banking operations 14,042 13,565 16,253 15,563
Other operating revenue (expense) 1,080 5,993 4,564 10,894
-------- -------- -------- --------
Net income $ 37,388 $ 39,671 $ 41,867 $ 41,000
======== ======== ======== ========
Net income per common share:
Basic 0.65 0.67 0.68 0.63
Diluted 0.58 0.60 0.61 0.57
Return on average stockholders' equity 19.76% 19.79% 19.58% 17.81%
</TABLE>
27
<PAGE> 27
CAPSTEAD MORTGAGE CORPORATION
NOTE 15 -- MARKET AND DIVIDEND INFORMATION (UNAUDITED)
The New York Stock Exchange trading symbol for the Company's common stock
is CMO. There were 6,248 holders of record of the Company's common stock at
December 31, 1998. In addition, depository companies held stock for 44,608
beneficial owners. The high and low stock sales prices and dividends declared on
common stock for the periods indicated were as follows:
<TABLE>
<CAPTION>
Year Ended December 31, 1998 Year Ended December 31, 1997
-------------------------------- ----------------------------------
Stock Prices Dividends Stock Prices Dividends
High Low Declared High Low Declared
---- --- -------- ---- --- --------
<S> <C> <C> <C> <C> <C> <C>
First quarter $21 11/16 $18 1/2 $0.50 $25 3/8 $19 1/2 $0.58
Second quarter 21 1/2 7 15/16 0.50 25 1/4 19 7/8 0.59 1/2
Third quarter 8 3/8 2 3/16 -- 27 13/16 24 1/2 0.61
Fourth quarter 4 5/8 2 1/8 -- 27 1/4 17 5/16 0.61 1/2
</TABLE>
28
<PAGE> 28
CAPSTEAD MORTGAGE CORPORATION
SELECTED FINANCIAL DATA
(In thousands, except percentages and per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
SELECTED CONSOLIDATED STATEMENT
OF OPERATIONS DATA:
Interest income $ 667,198 $ 694,259 $ 662,964 $ 623,160 $ 557,001
Interest and related expense 659,575 616,287 589,606 588,421 488,224
------------ ------------ ------------ ------------ ------------
Net margin on mortgage assets and
other investments 7,623 77,972 73,358 34,739 68,777
Net margin on mortgage banking operations* 11,821 59,422 49,122 41,253 21,019
Other operating revenue (expense)** (254,208) 22,532 4,748 1,367 (4,217)
------------ ------------ ------------ ------------ ------------
Net income (loss) $ (234,764) $ 159,926 $ 127,228 $ 77,359 $ 85,579
============ ============ ============ ============ ============
Net income (loss) per common share:***
Basic $ (4.22) $ 2.62 $ 2.37 $ 1.10 $ 1.36
Diluted (4.22) 2.35 2.07 1.09 1.34
Return on average stockholders' equity (28.83%) 19.12% 18.41% 11.91% 13.27%
Cash dividends paid per share:
Common $ 1.00 $ 2.40 $ 2.11 1/2 $ 1.09 1/3 $ 1.42 2/3
Series A Preferred 1.60 1.60 1.60 1.60 1.60
Series B Preferred 1.26 1.26 1.26 1.26 1.26
Average number of common shares
outstanding:***
Basic 60,948 51,257 38,317 34,631 34,316
Diluted 60,948 68,023 61,501 35,883 35,720
SELECTED CONSOLIDATED BALANCE SHEET DATA:
Mortgage securities and other investments $ 2,369,602 $ 6,114,130 $ 4,840,417 $ 4,556,049 $ 3,310,629
CMO collateral and investments 4,571,274 5,195,436 4,501,646 4,796,925 5,265,458
Mortgage servicing rights* -- 669,062 626,094 418,794 281,032
Total assets 7,100,287 12,357,515 10,157,338 9,903,606 8,943,858
Short-term borrowings 1,839,868 7,099,706 5,462,856 4,628,782 3,190,582
Collateralized mortgage obligations 4,521,324 4,309,455 3,861,892 4,538,863 5,102,145
Stockholders' equity 680,201 888,608 726,869 664,724 563,675
MORTGAGE BANKING DATA:*
Primary servicing portfolio $ -- $ 42,059,027 $ 35,562,597 $ 25,557,629 $ 14,392,182
Subservicing portfolio -- 11,834,091 2,155,873 -- --
</TABLE>
NOTE: See management's discussion and analysis of financial condition and
the notes to consolidated financial statement for discussion of
changes to the Company's operations in 1998 that are expected to
impact future operating results.
* The Company's mortgage banking operations, including related mortgage
servicing rights, were sold in December 1998.
** Included in other operating revenue (expense) in 1998 were
substantial losses incurred from the sale of mortgage assets,
principally interest-only mortgage securities.
*** Net income (loss) per common share and average number of common
shares outstanding amounts prior to 1997 have been restated as
required to comply with Statement of Financial Accounting Standards
No. 128, "Earnings per Share." For further discussion of net income
(loss) per common share, see the notes to the consolidated financial
statements. Amounts have been adjusted for 3-for-2 common stock
splits effective October 30, 1995 and July 31, 1996.
29
<PAGE> 29
CAPSTEAD MORTGAGE CORPORATION
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. Declining long-term interest rates throughout much of 1998 kept
long-term interest rates at or below short-term interest rates for most of the
year. This unfavorable interest rate environment led to significantly higher
mortgage prepayment rates, which negatively impacted yields and asset valuations
on most of the Company's mortgage assets, particularly on the Company's mortgage
servicing and interest-only mortgage-backed securities portfolios. These market
conditions contributed to liquidity issues for the mortgage finance industry as
the availability of financing diminished for all but the highest quality
mortgage assets. In response to these market conditions, the Company reduced its
mortgage asset portfolios, which included the disposition of a large portfolio
of interest-only mortgage-backed securities at a substantial loss, and sold its
mortgage banking operations for a modest gain. Combined with the temporary use
of the proceeds from the sale of the mortgage banking operations, these
reductions in mortgage assets contributed to lowering the Company's leverage
ratio (short-term borrowings to equity, before other comprehensive income
adjustments) from its peak of 8.7:1 at June 30, 1998 to 2.7:1 at December 31,
1998.
With the December 1998 sale of its mortgage banking operations, and reduced
mortgage asset holdings, the Company entered 1999 with substantial liquidity but
diminished earning capacity. Since year-end, the mortgage finance markets have
generally improved and the Company's borrowing rates have declined; however,
yields on mortgage assets continue to be depressed because of high mortgage
prepayments and the resetting of underlying adjustable-rate mortgage loans to
lower interest rate levels.
In early 1999, the Company began redeploying a portion of the proceeds from
the sale of its mortgage banking operations to increase holdings of high quality
mortgage-backed securities and may continue to do so. The Company also announced
a common and preferred stock repurchase program and that it is evaluating a
number of opportunities to acquire or make 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.
SALE OF MORTGAGE BANKING OPERATIONS
On December 21, 1998 the Company's subsidiary Capstead Inc. closed the sale
of its $38 billion mortgage servicing portfolio to GMAC Mortgage Corporation
("GMACMC"), an affiliate of GMAC Mortgage Group, Inc., (a wholly-owned
subsidiary of General Motors Acceptance Corporation ("GMAC")). On December 31,
1998 Capstead Inc. closed the sale of its mortgage banking operations to another
GMAC affiliate, Homecomings Financial Network, Inc. ("Homecomings"). A gain of
$2.9 million on these transactions was recorded as a component of Mortgage
banking revenue in the 1998 consolidated financial statements. Homecomings is a
wholly-owned subsidiary of Residential Funding Corporation ("RFC").
30
<PAGE> 30
CAPSTEAD MORTGAGE CORPORATION
Capstead Inc. has had a long-term subservicing relationship with RFC,
subservicing approximately $19 billion of RFC's single-family mortgage loans
just prior to the sale.
After retiring indebtedness related to the primary mortgage servicing
portfolio, related hedge instruments and loan production financing, and after
certain transaction costs, these transactions generated net cash proceeds of
approximately $500 million. Of these proceeds, $26.5 million is being held in
escrow for a period of up to 18 months to secure related indemnifications.
Included in the determination of the gain on these transactions was a prepayment
protection settlement payment of $16 million remitted to GMACMC in February 1999
pursuant to the servicing portfolio sale agreement, and an accrual of
approximately $7.2 million established for other contract settlement provisions
(principally concerned with pricing adjustments on mortgage servicing rights
acquisition agreements and final settlement on operating assets acquired and
obligations assumed by the buyers), and anticipated costs associated with
mortgage servicing and mortgage loan origination related contractual obligations
incurred prior to the sale. These costs include (i) completing trailing document
work associated with the primary mortgage servicing portfolio, (ii) completing
payoff processing for loans paid off prior to the sale, (iii) providing tax
information to mortgagors and vendors for calendar year 1998 and (iv)
indemnifying GMACMC for costs of mortgage loan buyback requests by investors in
excess of existing indemnifications by the originators of the loans. The Company
is unaware of any other material indemnification-related claims that may arise
prior to the release of the funds held in escrow.
MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities and other investments consist of high quality
single-family residential mortgage-backed securities, most of which are issued
by government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae
("Agency Securities"). The Company may also invest in government-issued
securities, commonly referred to as U.S. Treasury notes or bonds. Agency
Securities have no foreclosure risk. Non-agency securities consist of (i)
private mortgage pass-through securities whereby the related credit risk of the
underlying loans is borne by AAA-rated private mortgage insurers, (ii) other
AAA-rated private mortgage securities, or (iii) single-family residential
mortgage loans held for sale in connection with loan production activities
(together, "Non-agency Securities"). The Company classifies its mortgage
securities and other investments by interest rate characteristics of the
underlying loans (see NOTE 4 to the 1998 consolidated financial statements).
Mortgage securities and other investments are financed under repurchase
arrangements with investment banking firms pursuant to which the portfolios are
pledged as collateral (see "Liquidity and Capital Resources").
In response to market conditions discussed above, in the second quarter of
1998 the Company began reducing these portfolios in order to reduce short-term
borrowings and improve its credit profile by focusing almost exclusively on
Agency Securities. Sales of mortgage securities held in these portfolios totaled
$3.4 billion during the second, third and fourth quarters. In addition, the
Company sold U.S. Treasury notes held principally to help offset the effects of
impairment on the Company's investment in mortgage servicing rights.
31
<PAGE> 31
CAPSTEAD MORTGAGE CORPORATION
The following table depicts certain characteristics of mortgage securities
and other investments as of December 31, 1998. Note that acquisitions of
securities subsequent to year-end are not reflected.
<TABLE>
<CAPTION>
Net
Mortgage Securities Purchase Weighted Fourth Margin
and Principal Premium Average Quarter Over
Other Investments Balance (Discount) Basis Coupon Runoff Index
------------------- ------------ ------------ ------------ ------- ------- ------
* (Annualized) **
<S> <C> <C> <C> <C> <C> <C>
Agency Securities:
Fixed-rate $ 397,648 $ (731) $ 396,917 6.50% 14.59% --%
Medium-term 313,947 3,597 317,544 6.60 40.55 2.23
FNMA/FHLMC ARMs:
6-Month LIBOR 113,414 3,020 116,434 7.63 50.53 2.03
1-Year CMT 502,860 13,330 516,190 7.46 50.50 2.20
GNMA ARMs 871,308 14,635 885,943 6.75 37.24 1.50
------------ ------------ ------------ ------- -------
2,199,177 33,851 2,233,028 6.89 37.63
Non-agency Securities:
Fixed-rate 34,826 (11) 34,815 8.57 56.28 --
Mortgage loans held
for sale*** 105,892 (146) 105,746 6.77 1.52 --
------------ ------------ ------------ ------- ------- ------
$ 2,339,895 $ 33,694 $ 2,373,589 6.91% 36.27% 1.86%
============ ============ ============ ======= ======= ======
<CAPTION>
Mortgage Securities Maximum Months
and Annual to
Other Investments Reset Roll
------------------- ------ -----
**
<S> <C> <C>
Agency Securities:
Fixed-rate --%
Medium-term -- 34
FNMA/FHLMC ARMs:
6-Month LIBOR 2.00 3
1-Year CMT 2.00 7
GNMA ARMs 1.00 6
Non-agency Securities:
Fixed-rate -- --
Mortgage loans held
for sale*** -- --
------ -----
0.94% 11
====== =====
</TABLE>
* Recorded amount before mark to market, if applicable.
** Calculated excluding fixed-rate securities.
*** Represents loans originated by the mortgage banking operations prior to
its sale in December 1998. All such loans have been subsequently sold.
During 1998 adjustable-rate ("ARM") mortgage securities were particularly
hard hit by higher mortgage prepayments because homeowners found it increasingly
advantageous to refinance into fixed-rate mortgage loans with lower interest
rates. Expectations for future mortgage prepayments on ARM mortgage securities
peaked in early October 1998 when the 10-year U.S. Treasury rate reached a low
of 4.16 percent. Consequently, in the third quarter the Company wrote-off an
additional $5.3 million of the purchase premiums through premium amortization
adjustments. These write-offs and asset sales have decreased but not eliminated
the Company's exposure to future increases in prepayments relative to remaining
purchase premiums. Should future prepayments be realized at levels above the
Company's current expectations, additional write-offs of remaining premiums may
be necessary (see "Effects of Interest Rate Changes").
CMO COLLATERAL AND INVESTMENTS
Prior to 1995 the Company had been an active issuer of CMOs and other
securities backed by single-family residential mortgage loans. The related
credit risk of the underlying loans 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 $1.3 million of credit risk
in the form of subordinated bonds associated with these securities. The Company
also retained residual interests in 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 single-family
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CAPSTEAD MORTGAGE CORPORATION
residential mortgage loans underlying the securities. Other than occasional CMO
issuances (see below) the Company has not been an active issuer of CMOs since
1994.
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. The value of interest-only mortgage securities, which trade in
a market with relatively few participants, was significantly depressed in 1998
by increasingly high rates of current and anticipated future mortgage
prepayments and sales of such securities by a number of other large market
participants. Derivative financial instruments ("Derivatives"), specifically
interest rate floors, held to help offset the effects of falling interest rates
on the value of these securities, under-performed relative to the loss in value
of the interest-only mortgage securities due primarily to an overabundance of
other Derivatives in the marketplace, which effectively limited fair value
increases for the interest rate floors held by the Company. These value declines
and the prospect for further deterioration, compounded by the poor performance
of these Derivatives, led to the Company's decision to dispose of a $1.0 billion
interest-only mortgage securities portfolio in the second quarter for a loss of
$251.9 million, net of $28.3 million in gains on Derivatives. Remaining
investments in interest-only mortgage securities issued by others totaled $6.3
million at December 31, 1998.
With further increases in the third quarter of 1998 in mortgage prepayment
rates and expectations for future mortgage prepayments, the Company wrote off a
significant portion of remaining CMO investments through CMO bond discount
amortization adjustments aggregating $15.7 million and recorded a $4.1 million
other-than-temporary impairment charge to write down remaining investments in
interest-only mortgage securities to fair value. These write-offs have decreased
but not eliminated the Company's exposure to future increases in prepayments
relative to remaining CMO investments. Should future prepayments increase beyond
the Company's current expectations, additional write-downs of remaining CMO
collateral premiums and bond discounts may be necessary (see "Effects of
Interest Rate Changes"). As of December 31, 1998, the Company's CMO investments
had been reduced to $50.0 million, down from $886.0 million at December 31,
1997. Included in this net investment are $11.8 million and $17.8 million of
remaining CMO collateral premiums and bond discounts, respectively.
Since the Company exited the mortgage loan conduit business in 1995, it has
maintained several 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
the Company's CMO administration activities, the Company may, from time to time,
purchase mortgage loans from originators or conduits and issue CMOs or other
securities backed by these loans. The Company may or may not retain a
significant residual economic interest in these securitizations. In the latter
half of 1997, the Company completed two such CMO transactions totaling $1.1
billion and during 1998 issued two additional such CMOs totaling $1.1 billion.
Additionally, in the third quarter of 1998, the Company issued a $345.4 million
CMO backed by Non-agency Securities, retaining a $6.1 million residual interest.
MORTGAGE BANKING OPERATIONS
The Company commenced mortgage servicing operations in 1993 and grew the
operation into one of the 20 largest mortgage servicers in the country with a
total mortgage servicing
33
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CAPSTEAD MORTGAGE CORPORATION
portfolio (including primary servicing and subservicing) of $57 billion prior
to its sale in December 1998. In February 1998 the Company entered the mortgage
production business, which was also sold.
Because of the increasingly high rates of current and anticipated future
mortgage prepayments experienced during 1998, expectations for future cash flows
from the mortgage servicing portfolio continued to deteriorate during 1998. As a
result, substantially higher amortization expense and substantial impairment
charges were recorded, which could not be offset by the Company's risk
management strategies and startup mortgage production business. In the past the
Company attempted to help offset the effects of falling interest rates on the
value of its investment in mortgage servicing rights with Derivatives,
specifically interest rate floors. These instruments under-performed during the
first half of 1998 relative to the decline in the value of the mortgage
servicing portfolio due primarily to the interest rate floor market conditions
mentioned above. In July 1998 the Company began managing an expanded portfolio
of U.S. Treasury-based financial instruments that included interest rate floors,
10-year U.S. Treasury note futures contracts and 10-year U.S. Treasury notes to
help mitigate the effects of further declines in mortgage interest rates on the
value of mortgage servicing rights. These instruments performed well in the
second half of 1998 relative to declines in value of the servicing portfolio
because of significant declines in U.S. Treasury rates caused in part by global
market instability and because mortgage interest rates did not decline to the
same extent as U.S. Treasury rates (see "Results of Operations" and "Effects of
Interest Rate Changes").
UTILIZATION OF CAPITAL AND POTENTIAL LIQUIDITY
The following table summarizes the Company's utilization of capital and
potential liquidity as of December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
Capital Potential
Assets Borrowings Employed Liquidity
---------- ---------- ---------- ----------
*
<S> <C> <C> <C> <C>
Agency securities:
Fixed-rate $ 400,345 $ 388,668 $ 11,677 $ 349
Medium-term 318,033 119,339 198,694 187,705
Adjustable-rate 1,509,807 1,303,023 206,784 152,743
Non-agency Securities:
Fixed-rate 35,671 -- 35,671 34,215
Production warehouse 105,746 28,838 76,908 74,608
CMO collateral and investments 4,571,274 4,521,324 49,950 12,500
---------- ---------- ---------- ----------
$6,940,876 $6,361,192 579,684 462,120
========== ==========
Other assets, net of other liabilities 100,517 73,385**
---------- ----------
$ 680,201 $ 535,505
========== ==========
</TABLE>
* Based on maximum borrowings available under existing uncommitted
repurchase arrangements considering the fair value of related
collateral as of December 31, 1998 (see "Liquidity and Capital
Resources").
** Represents unrestricted cash and cash equivalents (see NOTE 2 to the
consolidated financial statements).
The Company raised $51.9 million of new capital earlier in 1998 through the
issuance of stock (i) directly to investors pursuant to its direct stock
purchase and dividend reinvestment programs, (ii) daily sales of stock into the
open market and (iii) stock compensation
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<PAGE> 34
CAPSTEAD MORTGAGE CORPORATION
programs. Effective early in June 1998, the Company suspended its stock
purchase program and open market sales until further notice and in December
1998 repurchased 1 million shares of common stock for $4.1 million. Due
primarily to losses incurred during the year, total stockholders' equity
decreased $208.4 million to $680.2 million at December 31, 1998 compared to
$888.6 million at December 31, 1997. Book values per common share outstanding
at the respective balance sheet dates were as follows:
<TABLE>
<CAPTION>
December 31
-------------------
1998 1997
-------- ---------
<S> <C> <C>
Assuming liquidation of preferred stock* $ 7.88 $ 11.74
Assuming redemption of preferred stock** 7.56 11.42
</TABLE>
* 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.
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):
<TABLE>
<CAPTION>
Year Ended December 31
---------------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Agency and U.S. Treasury Securities $ 12,754 $ 31,892 $ 35,082
Non-agency Securities 4,947 5,867 9,867
CMO collateral and investments (10,078) 40,213 28,409
Mortgage banking operations 11,821 59,422 49,122
CMO administration and other 4,598 4,000 3,730
--------- --------- ---------
Contribution to income 24,042 141,394 126,210
Gain (loss) on sale of mortgage assets and
related Derivatives (245,261) 27,737 15,991
Impairment on CMO investments (4,051) -- --
Other operating expense (9,494) (9,205) (14,973)
--------- --------- ---------
Net income (loss) $(234,764) $ 159,926 $ 127,228
========= ========= =========
Net income (loss) per common share:
Basic $ (4.22) $ 2.62 $ 2.37
Diluted (4.22) 2.35 2.07
</TABLE>
1998 COMPARED TO 1997
Operating results for the year ended December 31, 1998 reflect the impact
on the Company of the unfavorable interest rate environment and market
conditions experienced in 1998 and steps taken by the Company in response
including reducing its mortgage asset portfolios and culminating in the sale of
the mortgage banking operations in December 1998 for a gain of $2.9 million (see
above, "Financial Condition"). In reducing its mortgage asset portfolios, the
Company incurred losses of $245.3 million including a $251.9 million loss, net
of related gains on Derivatives, on the disposition of a $1.0 billion portfolio
of interest-
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CAPSTEAD MORTGAGE CORPORATION
only mortgage securities in the second quarter. Net interest margins on the
Company's mortgage asset portfolios were dramatically reduced by (i) the
effects of high prepayments which reduced yields on mortgage assets and (ii)
declining earning capacity due to reduced holdings. Mortgage banking results
also reflect the effects of high prepayments through higher mortgage servicing
amortization expenses and impairment charges that were not totally offset by
this operation's risk management strategies and limited mortgage production
capacity.
Since year-end, the mortgage finance markets have generally improved and
the Company's borrowing rates have declined; however, yields on mortgage assets
continue to be depressed because of high mortgage prepayments and the resetting
of underlying adjustable-rate mortgage loans to lower interest rate levels. In
early 1999 the Company began deploying a portion of the proceeds from the sale
of its mortgage banking operations to increase holdings of high quality
mortgage-backed securities and may continue to do so. The earning capacity of
the Company's mortgage asset portfolios are largely dependent on the extent to
which the Company increases these portfolios and the relationship between short-
and long-term interest rates (the "yield curve"). A 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"). Additionally, the Company
is evaluating a number of opportunities to acquire or make 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.
Agency Securities contributed less to operating results during 1998 than in
1997 due primarily to a 38-basis point decrease in financing spreads. The
average outstanding portfolio peaked at $6.5 billion in May 1998 before being
reduced by asset sales and runoff to an average of $2.3 billion in December
1998. Average yields for this portfolio were 5.77 percent during 1998 compared
to 6.18 percent during 1997, while average borrowing rates were slightly lower
at 5.54 percent during 1998 compared to 5.57 percent during 1997. Lower yields
reflect increased amortization of purchase premiums and investments in
relatively low coupon 10-year U.S. Treasury notes. Additionally, lower 6-month
LIBOR and 1-year U.S. Treasury rates have contributed to declining yields on ARM
securities because underlying ARM loans reset periodically based on those
indices.
Non-agency Securities contributed less to operating results during 1998
than in 1997 due primarily to a 22-basis point decrease in financing spreads.
The average outstanding portfolio peaked at $705 million in March 1998 before
being reduced by runoff, sales and a $345.4 million CMO issuance. Average yields
for this portfolio (calculated including mortgage insurance costs) were 6.79
percent during 1998 compared to 6.96 percent during 1997, while average
borrowing rates were marginally higher at 5.80 percent during 1998 compared to
5.75 percent during 1997.
CMO investments contributed substantially less to operating results in 1998
than in 1997 primarily because of the disposition of the Agency Trust
interest-only mortgage securities in June 1998, which significantly diminished
the earning capacity of this portfolio. With the increase in expectations for
future mortgage prepayments as discussed above, the Company wrote off a
significant portion of remaining CMO investments through CMO bond discount
amortization adjustments aggregating $15.7 million and recorded a $4.1 million
other-than-temporary impairment charge to write down remaining investments in
interest-only mortgage securities to fair value. Average yields for this
portfolio declined to 6.32 percent during
36
<PAGE> 36
CAPSTEAD MORTGAGE CORPORATION
1998 from 10.24 percent during 1997. Yields were negatively impacted by the
downsizing of this portfolio and the effects of high prepayments.
Mortgage banking revenues increased to $206.1 million in 1998 compared to
$172.9 million in 1997 due to growth of the new mortgage production operation,
higher earnings on temporarily-held cash balances and the $2.9 million gain on
sale of this operation. Amortization expenses of $95.2 million and impairment
charges of $224.7 million recorded in 1998 reflect the effects of high
prepayments (including the prospect of continued high prepayments) on the value
of the mortgage servicing portfolio. After recording an impairment charge of
$45.0 million in the second quarter, net of related gains on Derivatives, the
Company's decision in July 1998 to actively manage an expanded portfolio of U.S.
Treasury-based financial instruments to more fully protect the value of the
Company's investment in mortgage servicing rights substantially offset
impairment charges recorded in the third and fourth quarters of 1998.
Operating expenses during 1998 were comparable to 1997 in total. Higher
general and administrative costs and lower allocations of costs to the mortgage
banking operations were all but offset by lower compensation-related accruals.
With the sale of the mortgage banking operations, ongoing operating expenses are
expected to be significantly lower.
Excluding the loss on sale of the Agency Trust interest-only mortgage
securities and related gains on Derivatives, the Company recorded gains of $2.3
million on the sale of $3.8 billion of mortgage assets. In addition, the Company
earned $3.8 million in 1998 from a strategy of writing call options on a portion
of the Company's fixed-rate securities. During 1997 the Company sold $2.0
billion of mortgage assets for gains totaling $27.0 million. Derivatives not
designated as hedges contributed $708,000 to operating results during 1997.
1997 COMPARED TO 1996
Operating results for 1997 exceeded 1996 results due primarily to the
benefit of larger holdings of mortgage assets, offset somewhat by a narrowing of
financing spreads due to high levels of prepayments and higher short-term
borrowing rates. Likewise, mortgage servicing results, while benefiting from
significant growth in the servicing portfolio in 1996 and 1995, were hampered by
higher amortization of mortgage servicing rights due to high prepayments.
Agency Securities contributed less to income during 1997 than in 1996. The
benefit to operating results of an $891 million (22 percent) increase in average
holdings of these securities to $4.9 billion during 1997 was offset by declining
financing spreads primarily because of higher prepayments. Additionally, lower
6-month LIBOR and 1-year U.S. Treasury rates led to declining yields on ARM
securities because underlying ARM loans reset periodically to those indices.
Finally, yields on acquisitions of newly created ARM securities trended lower
because many of those securities had initial mortgage interest rates below the
referenced indices (referred to as "teaser-rate ARM securities"). During 1997
financing spreads averaged only 20 basis points lower at 61-basis points;
however, financing spreads for the fourth quarter of 1997 of 28-basis points
were 65-basis points lower than spreads achieved in the fourth quarter of 1996.
Average yields for this portfolio were 6.18 percent during 1997 compared to 6.24
percent during 1996, while average borrowing rates were higher at 5.57 percent
compared to 5.43 percent during 1996.
Non-agency Securities contributed less to income during 1997 than in 1996
due primarily to a 13-basis point decrease in financing spreads and a $206
million (30 percent) reduction in
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<PAGE> 37
CAPSTEAD MORTGAGE CORPORATION
the average holdings of those securities to $476 million. Average yields for
this portfolio (calculated including mortgage insurance costs) were 6.96
percent during 1997 compared to 7.01 percent during 1996, while average
borrowing rates were higher at 5.75 percent during 1997 compared to 5.67
percent during 1996.
CMO investments contributed substantially more to income in 1997 than in
1996 primarily because of investments made during 1996 and 1995 in interest-only
mortgage securities. Average yields for this portfolio (after hedging costs)
declined to 10.24 percent during 1997 from 11.85 percent during 1996. Yields
were negatively impacted by higher prepayments and increased hedging costs.
Higher mortgage banking results reflected continued growth in this
operation. Revenues increased to $173 million in 1997 compared to $131 million
in 1996. Servicing expenses also increased, but not to the same extent as
revenues, reflecting further efficiencies gained in the servicing process with
continued growth in the servicing portfolio. Amortization of mortgage servicing
rights of $65 million during 1997 was higher than the $45 million recorded in
1996 due to portfolio growth and higher levels of prepayments caused by lower
prevailing mortgage interest rates. Greater use of external borrowings secured
by the mortgage servicing portfolio to finance portfolio growth contributed to
higher borrowing costs in 1997 compared to 1996.
Operating expenses during 1997 were lower than 1996 primarily because of
lower compensation-related accruals.
During 1997 the Company sold $2.0 billion of mortgage assets for gains
totaling $27.0 million. This compares to sales of mortgage assets totaling $667
million during 1996 for gains of $14.9 million. Derivatives not designated as
hedges contributed $708,000 to operating results during 1997 compared to $1.1
million during 1996.
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 liquidity with the
proceeds from the December 1998 sale of its mortgage banking operations (see
above "Financial Condition"), which have been temporarily 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
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<PAGE> 38
CAPSTEAD MORTGAGE CORPORATION
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 remaining investments that it finances 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 $1.26
Cumulative Convertible Preferred Stock, Series B. The Company may repurchase the
shares in open market transactions from time to time subject to the price of its
securities and alternative investment opportunities.
With the sale of the mortgage banking operations, the Company terminated a
repurchase arrangement to fund a portion of its production warehouse, which was
liquidated subsequent to year-end, and a revolving line of credit agreement with
an investment banking firm which was collateralized by mortgage servicing
rights.
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. As of December 31, 1998, the Company had the
following estimated earnings sensitivity profile:
<TABLE>
<CAPTION>
Immediate Change In:
(rates in basis points, dollars in thousands)
----------------------------------------------------
<S> <C> <C> <C> <C>
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* $(424) $12,757 $8,065 $(4,775)
</TABLE>
* Note that the impact of actual or planned acquisitions of mortgage
assets subsequent to year-end 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, cash flows and maturities of Derivatives and other financial
instruments, changes in market conditions, and management's financial capital
plans. These assumptions are inherently uncertain and, as a
39
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CAPSTEAD MORTGAGE CORPORATION
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 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 offset to some extent by increases in the
rates of interest earned on the underlying ARM loans. Since ARM loans generally
limit the amount of such increase 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 ARM loans resulting
in a negative financing spread. The Company may invest in Derivatives from time
to time, specifically interest rate caps, as a hedge against rising interest
rates on a portion of its short-term borrowings. Interest rate caps generally
increase in value as related interest rates rise and decline in value when such
rates fall.
Another effect of changes in interest rates is that, as long-term interest
rates decrease, the rate of prepayment of mortgage loans underlying mortgage
investments generally increases. To the extent the proceeds of prepayments on
mortgage investments cannot be reinvested at a rate of interest at least equal
to the rate previously earned on such investments, earnings may be adversely
affected. As seen in 1998 prolonged periods of high prepayments can
significantly reduce the expected life of mortgage investments; therefore, the
actual yields realized can be lower due to faster amortization of purchase
premiums. In addition, the rates of interest earned on ARM investments generally
will decline during periods of falling short-term interest rates as the
underlying ARM loans reset at lower rates.
Changes in interest rates also impact earnings recognized from CMO
investments, which have consisted primarily of interest-only mortgage securities
and fixed-rate CMO residuals (see above "Financial Condition"). The amount of
income that may be generated from interest-only mortgage securities is dependent
upon the rate of principal prepayments on the underlying mortgage collateral. If
mortgage interest rates fall significantly below interest rates on the
collateral, principal prepayments 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.
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
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CAPSTEAD MORTGAGE CORPORATION
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 reposition
investment 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 above discussion regarding how changes in interest rates impact
mortgage assets also applied to the Company's investment in mortgage servicing
rights, which was sold in December 1998. When mortgage interest rates rise,
periodic amortization of amounts paid for mortgage servicing rights is less
since the average lives of the related mortgage loans tend to be longer. Under
these conditions, mortgage servicing rights become more valuable. Conversely,
lower mortgage interest rates will spur prepayments thus reducing the time the
Company can service the related loans. As seen in 1998, sustained periods of
high prepayments can result in losses on the Company's investment in mortgage
servicing rights, particularly since this investment is evaluated for impairment
on a disaggregated basis and impairment charges are necessary if the recorded
amount for an individual servicing stratum exceeds its fair value.
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 see 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 nearly all 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.
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CAPSTEAD MORTGAGE CORPORATION
State of Readiness. The Company has made and will continue to make
investments in its software systems and applications to ensure the Company is
Year 2000 compliant. The Company is also taking steps to ensure that the vendors
it utilizes and institutions that it interfaces with are also taking the
necessary steps to become Year 2000 compliant. This process is expected to be
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
will take all prudent steps necessary to ensure operations are not disrupted
including the use of other vendors or other methodologies and processes to
transact the Company's business. The effect of any disruption to the Company's
operations of any such instances of non-compliance 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, changes in net asset
value 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, Year 2000 compliance failures, 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, increases in costs and
other general competitive factors.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for Derivatives and hedging activities. It requires that an
entity recognize all Derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. If
certain conditions are met, a Derivative may be specifically designated as (i) a
hedge of the exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment; (ii) a hedge of the exposure to
variable cash flows of a forecasted transaction; or (iii) in certain
circumstances, a hedge of a foreign currency exposure. This statement will
become effective for the Company's fiscal year ending December 31, 2000. The
adoption of SFAS 133 is not expected to have a material impact on the financial
position of the Company.
42
<PAGE> 1
EXHIBIT 21
LIST OF SUBSIDIARIES OF
CAPSTEAD MORTGAGE CORPORATION
At December 31, 1998 the subsidiaries of Capstead Mortgage Corporation were as
follows:
<TABLE>
<CAPTION>
STATE OF
DOMICILE
- -------------------------------------------------------------------------------------------------------------
PARENT COMPANY
SUBSIDIARY
<S> <C>
Capstead Mortgage Corporation ("CMC")................................................... Maryland
Capstead Advisers, Inc............................................................... Nevada
Capstead Capital Corporation......................................................... Delaware
Capstead Select Corporation.......................................................... Delaware
Capstead Securities Corporation I.................................................... Delaware
Capstead Securities Corporation II................................................... Delaware
Capstead Securities Corporation III.................................................. Delaware
Capstead Securities Corporation IV................................................... Delaware
CMC Securities Corporation I......................................................... Nevada
CMC Securities Corporation III....................................................... Delaware
CMC Securities Corporation IV........................................................ Delaware
CMC ARM Securities Corporation....................................................... Delaware
Capstead Mortgage Services Corporation............................................... Delaware
Capstead Holdings, Inc.(1)........................................................... Delaware
Capstead Inc.(2)................................................................... Delaware
CMC Securities Corporation II(2)................................................... Delaware
CMC Investment Partnership(3)........................................................... Texas
</TABLE>
(1) CMC owns all of the issued and outstanding preferred stock.
(2) Capstead Holdings, Inc. owns all the issued and outstanding common stock.
(3) A general partnership owned by CMC and Capstead Holdings, Inc.
<PAGE> 1
EXHIBIT 23
CONSENT OF ERNST & YOUNG LLP
INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of Capstead Mortgage Corporation of our report dated February 4, 1999, included
in the 1998 Annual Report to Stockholders of Capstead Mortgage Corporation. We
also consent to the incorporation by reference in the following registration
statements and the related prospectuses, our report dated February 4, 1999, with
respect to the consolidated financial statements incorporated herein by
reference, in the Form 10-K of Capstead Mortgage Corporation:
o Form S-8 (No. 33-40116);
o Form S-8 (No. 33-40117);
o Form S-3 (No. 33-62212);
o Form S-3 (No. 33-52415);
o Form S-8 (No. 33-53555);
o Form S-3 (No. 33-57164);
o Form S-3 (No. 333-03187);
o Form S-8 (No. 333-12719);
o Form S-3 (No. 333-26419);
o Form S-3 (No. 333-26865);
o A pre-effective amendment to Form S-3 (No. 333-26419);
o Form S-8 (No. 333-27215);
o A post-effective amendment to Form S-3 (No. 333-26865); and
o Form S-3 (No. 333-43169).
/s/ ERNST & YOUNG LLP
Dallas, Texas
March 29, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CAPSTEAD
MORTGAGE CORPORATION ANNUAL REPORT ON FORM 10-K FOR THE PERIOD ENDED DECEMBER
31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 73,385
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 7,100,287
<CURRENT-LIABILITIES> 1,898,762
<BONDS> 4,521,324
0
198,424
<COMMON> 605
<OTHER-SE> 481,172
<TOTAL-LIABILITY-AND-EQUITY> 7,100,287
<SALES> 0
<TOTAL-REVENUES> 877,885
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 439,416
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 673,233
<INCOME-PRETAX> (234,764)
<INCOME-TAX> 0
<INCOME-CONTINUING> (234,764)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (234,764)
<EPS-PRIMARY> (4.22)
<EPS-DILUTED> (4.22)
</TABLE>
