<PAGE> 1
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
----------- ------------
COMMISSION FILE NUMBER: 1-8996
CAPSTEAD MORTGAGE CORPORATION
(Exact name of Registrant as specified in its Charter)
MARYLAND 75-2027937
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2711 NORTH HASKELL, DALLAS, TEXAS 75204
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 874-2323
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date.
Common Stock ($0.01 par value) 58,338,720 as of May 3, 1999
================================================================================
<PAGE> 2
CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1999
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. -- FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Balance Sheet -- March 31, 1999 and December 31, 1998.............. 3
Consolidated Statement of Operations -- Quarter Ended March 31, 1999 and 1998... 4
Consolidated Statement of Cash Flows -- Quarter Ended March 31, 1999 and 1998... 4
Notes to Consolidated Financial Statements...................................... 5
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............................ 13
ITEM 3. Qualitative and Quantitative Disclosure of Market Risk..................... 23
PART II. -- OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K........................................... 23
SIGNATURES......................................................................... 24
</TABLE>
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<PAGE> 3
PART I. -- FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
-------------- -----------------
(unaudited)
<S> <C> <C>
ASSETS
Mortgage securities and other investments $ 5,387,676 $ 2,369,602
CMO collateral and investments 4,039,550 4,571,274
----------- -----------
9,427,226 6,940,876
Prepaids, receivables and other 50,348 59,526
Cash and cash equivalents 8,025 73,385
Restricted cash 25,208 26,500
----------- -----------
$ 9,510,807 $ 7,100,287
=========== ===========
LIABILITIES
Short-term borrowings $ 4,802,199 $ 1,839,868
Collateralized mortgage obligations 4,001,716 4,521,324
Accounts payable and accrued expenses 18,313 58,894
----------- -----------
8,822,228 6,420,086
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value; 100,000 shares authorized:
$1.60 Cumulative Preferred Stock, Series A, 374 shares
issued ($6,134 aggregate liquidation preference) 5,228 5,228
$1.26 Cumulative Convertible Preferred Stock, Series B,
17,179 and 17,298 shares issued ($195,497 aggregate
liquidation preference) 191,871 193,196
Common stock - $0.01 par value; 100,000 shares authorized;
58,702 and 60,546 shares issued 587 605
Paid-in capital 778,391 787,677
Undistributed income (loss) (297,065) (305,287)
Accumulated other comprehensive income (loss) 9,567 (1,218)
----------- -----------
688,579 680,201
----------- -----------
$ 9,510,807 $ 7,100,287
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE> 4
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Quarter Ended
March 31
----------------------
1999 1998
--------- ---------
<S> <C> <C>
INTEREST INCOME:
Mortgage securities and other investments $ 47,312 $ 98,784
CMO collateral and investments 77,030 94,235
--------- ---------
Total interest income 124,342 193,019
--------- ---------
INTEREST AND RELATED EXPENSE:
Short-term borrowings:
Mortgage securities and other investments 33,914 88,410
CMO investments -- 11,326
Collateralized mortgage obligations 77,517 77,803
Mortgage insurance and other 627 1,112
--------- ---------
Total interest and related expense 112,058 178,651
--------- ---------
Net margin on mortgage assets and other investments 12,284 14,368
--------- ---------
NET MARGIN ON MORTGAGE BANKING OPERATIONS
-- 14,845
--------- ---------
OTHER OPERATING REVENUE (EXPENSE):
Gain on sale of mortgage assets and derivative
financial instruments 1,738 6,869
CMO administration and other 1,470 829
Other operating expense (1,585) (1,841)
--------- ---------
Total other operating revenue (expense) 1,623 5,857
--------- ---------
NET INCOME $ 13,907 $ 35,070
========= =========
Net income $ 13,907 $ 35,070
Less cash dividends on preferred stock (5,684) (5,555)
--------- ---------
Net income available to common stockholders $ 8,223 $ 29,515
========= =========
NET INCOME PER COMMON SHARE:
Basic $ 0.14 $ 0.50
Diluted 0.14 0.48
CASH DIVIDENDS PAID PER SHARE:
Common $ -- $ 0.500
Series A Preferred 0.400 0.400
Series B Preferred 0.315 0.315
</TABLE>
See accompanying notes to consolidated financial statements.
-4-
<PAGE> 5
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Quarter Ended
March 31
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 13,907 $ 35,070
Noncash items:
Amortization of mortgage servicing rights and related costs -- 19,928
Amortization of discount and premium 11,409 42,563
Depreciation and other amortization 286 1,465
Gain on sale of mortgage assets and derivative financial instruments (1,738) (6,826)
Net change in prepaids, receivables, other assets, accounts
payable and accrued expenses (31,912) (4,259)
----------- -----------
Net cash provided (used) by operating activities (8,048) 87,941
----------- -----------
INVESTING ACTIVITIES:
Purchases of mortgage securities and other investments (3,319,728) (1,778,499)
Purchases of CMO collateral and investments -- (721,174)
Purchases of mortgage servicing rights -- (39,832)
Purchases of derivative financial instruments -- (54,250)
Principal collections on mortgage investments 295,380 568,790
Proceeds from sales of mortgage assets 114,763 682,690
Proceeds from sales and settlement of derivative financial instruments 12,595 32,360
CMO collateral:
Principal collections 404,123 202,891
Decrease in accrued interest receivable 3,607 1,841
Decrease (increase) in short-term investments 11,116 (2,509)
----------- -----------
Net cash used by investing activities (2,478,144) (1,107,692)
----------- -----------
FINANCING ACTIVITIES:
Increase in short-term borrowings 2,962,331 678,220
Increase in mortgage servicing acquisitions payable -- 25,385
Collateralized mortgage obligations:
Issuances of securities -- 597,934
Principal payments on securities (521,551) (264,118)
Decrease in accrued interest payable (3,635) (1,012)
Capital stock transactions (10,629) 28,843
Dividends paid (5,684) (35,633)
----------- -----------
Net cash provided by financing activities 2,420,832 1,029,619
----------- -----------
Net change in cash and cash equivalents (65,360) 9,868
Cash and cash equivalents at beginning of period 73,385 17,377
----------- -----------
Cash and cash equivalents at end of period $ 8,025 $ 27,245
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
-5-
<PAGE> 6
CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
NOTE 1 -- BUSINESS
Capstead Mortgage Corporation, a mortgage investment firm, earns income from
investing in mortgage assets on a leveraged basis and from other investment
strategies. With the restructuring of the Company's mortgage asset portfolios
that began in June 1998 and the sale of the mortgage banking operations in
December 1998, the Company has excess capital and liquidity of more than $450
million. Currently, the Company is investing its excess liquidity primarily in
mortgage-backed securities issued by government-sponsored entities, either
Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities"). In addition, the
Company continues to evaluate a number of opportunities to acquire or make
strategic investments in a variety of real estate-related investments and
entities. However, the Company may conclude to substantially limit its
activities to investing in Agency Securities.
NOTE 2 -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the quarter ended March 31, 1999 are not
necessarily indicative of the results that may be expected for the calendar year
ending December 31, 1999. For further information refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-K for the year ended December 31, 1998.
NOTE 3 -- SHARE REPURCHASES AND DECLARATION OF COMMON STOCK DIVIDEND
On February 4, 1999 the Company's board of directors authorized the repurchase
of up to 6,000,000 shares of its common stock and up to 2,000,000 shares of its
$1.26 Cumulative Convertible Preferred Stock, Series B (the "Series B Preferred
Stock"). Subsequently the Company repurchased, as of March 31, 1999, 1,759,600
shares of common stock at an average price of $5.09 (including transaction
costs) and 118,600 shares of the Series B Preferred Stock at an average price of
$11.99 (including transaction costs). In December 1998 the Company completed a
previously authorized repurchase of 1 million shares of common stock at an
average price of $4.10 per share (including transaction costs). In early January
another 85,583 shares were repurchased from employees at $4.12 per share in
connection with the lapsing of restrictions on stock awards with the December
1998 sale of the mortgage banking operations. Altogether the Company has
repurchased over 4.5 percent of its outstanding shares of common stock since the
first share repurchases in December 1998. All such repurchased shares have been
canceled and returned to authorized but unissued shares.
On April 22, 1999 the board of directors declared a first quarter dividend of 14
cents per common share, payable May 20, 1999 to stockholders of record as of May
3, 1999.
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<PAGE> 7
NOTE 4 -- MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities investments and the related average effective interest rates
(calculated for the quarter then ended including mortgage insurance costs on
non-agency securities and excluding unrealized gains and losses) were as follows
(dollars in thousands):
<TABLE>
<CAPTION>
Average
Principal Premium Carrying Average Effective
Balance (Discount) Basis Amount Coupon Rate
----------- ----------- ----------- ----------- ------- ---------
* ** **
<S> <C> <C> <C> <C> <C> <C>
MARCH 31, 1999
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 1,103,896 $ (3,284) $ 1,100,612 $ 1,097,365 6.17% 6.31%
Medium-term 846,244 5,909 852,153 854,509 6.24 5.83
Adjustable-rate ("ARMs"):
LIBOR/CMT 928,055 22,598 950,653 951,179 7.23 5.22
COFI 252,338 1,669 254,007 253,836 5.94 6.19
GNMA ARMs 2,065,561 33,472 2,099,033 2,106,234 6.32 5.67
Non-agency securities:
Fixed-rate 123,729 167 123,896 124,553 8.54 8.24
Mortgage loans held
for sale*** -- -- -- -- -- 6.51
----------- ----------- ----------- -----------
$ 5,319,823 $ 60,531 $ 5,380,354 $ 5,387,676
=========== =========== =========== ===========
DECEMBER 31, 1998
Agency and U.S. Treasury
securities:
U.S. Treasury notes $ -- $ -- $ -- $ -- --% 4.68%
FNMA/FHLMC:
Fixed-rate 397,648 (731) 396,917 400,345 6.50 6.42
Medium-term 313,947 3,597 317,544 318,033 6.60 5.67
LIBOR/CMT ARMs 616,274 16,350 632,624 626,356 7.49 5.24
GNMA ARMs 871,308 14,635 885,943 883,451 6.75 5.76
Non-agency securities:
Fixed-rate 34,826 (11) 34,815 35,671 8.57 8.54
Mortgage loans held
for sale*** 105,892 (146) 105,746 105,746 6.77 6.79
----------- ----------- ----------- -----------
$ 2,339,895 $ 33,694 $ 2,373,589 $ 2,369,602
=========== =========== =========== ===========
</TABLE>
* Includes mark-to-market for securities classified as available-for-sale, if
applicable (see NOTE 7).
** Average Coupon is calculated as of the indicated balance sheet date.
Average Effective Rate is calculated for the quarter then ended.
*** Represents loans originated prior to the sale of the mortgage banking
operations in December 1998. All such loans have been subsequently sold.
The Company classifies its mortgage securities by interest rate characteristics
of the underlying single-family residential mortgage loans. Fixed-rate mortgage
securities either (i) have fixed rates of interest for their entire terms, (ii)
have an initial fixed-rate period of 10 years after origination and then adjust
annually based on a specified margin over 1-year U.S. Treasury Securities
("1-year Treasuries"), or (iii) were previously classified as medium-term and
have adjusted to a fixed rate for the remainder of their terms. Medium-term
mortgage securities either (i) have an initial fixed-rate period of 3 or 5 years
after origination and then adjust annually based on a specified margin over
1-year Treasuries, (ii) have initial interest rates that adjust one time,
approximately 5 years following origination of the mortgage loan, based on a
specified margin over Fannie Mae yields for 30-year, fixed-rate commitments at
the time of
-7-
<PAGE> 8
adjustment, or (iii) fixed-rate mortgage securities that have expected weighted
average lives of 5 years or less. Adjustable-rate mortgage securities either (i)
adjust semiannually based on a specified margin over the 6-month London
Interbank Offered Rate ("LIBOR"), (ii) adjust annually based on a specified
margin over 1-year Treasuries ("CMT"), (iii) adjust monthly based on a specific
margin over the Cost of Funds Index as published by the Eleventh District
Federal Reserve Bank ("COFI"), or (iv) were previously classified as medium-term
and have begun adjusting annually based on a specified margin over 1-year
Treasuries.
Agency and U.S. Treasury securities consist of Agency Securities and U.S.
government-issued fixed-rate securities, commonly referred to as U.S. Treasury
notes or bonds (collectively, "Agency and U.S. Treasury Securities"). Agency
Securities have no foreclosure risk. Non-agency securities consist of (i)
private mortgage pass-through securities backed primarily by single-family
jumbo-sized residential mortgage loans whereby the related credit risk of the
underlying loans is borne by AAA-rated private mortgage insurers, (ii) other
AAA-rated private mortgage securities, or (iii) single-family residential
mortgage loans held for sale in connection with loan production activities
(collectively, "Non-agency Securities"). The maturity of mortgage-backed
securities is directly affected by the rate of principal prepayments on the
underlying loans.
NOTE 5 -- CMO COLLATERAL AND INVESTMENTS
Collateralized mortgage obligation ("CMO") collateral consists of (i)
fixed-rate, medium-term and adjustable-rate mortgage securities collateralized
by single-family residential mortgage loans and (ii) related short-term
investments, both pledged to secure CMO borrowings ("Pledged CMO Collateral").
CMO investments have included investments in interest-only mortgage securities
and investments in other CMO securities such as principal-only mortgage
securities. Interest-only mortgage securities are entitled to receive 100
percent of coupon interest stripped from pools of mortgage loans. The components
of CMO collateral and investments are summarized as follows (in thousands):
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
-------------- -----------------
<S> <C> <C>
Pledged CMO Collateral:
Pledged mortgage securities $3,996,256 $4,507,337
Short-term investments 3,762 14,879
Accrued interest receivable 23,755 27,361
---------- ----------
4,023,773 4,549,577
Unamortized premium 12,145 11,830
---------- ----------
4,035,918 4,561,407
CMO investments 3,632 9,867
---------- ----------
$4,039,550 $4,571,274
========== ==========
</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 reinvestment income earned thereon are
available for the payment of principal and interest on CMO borrowings. Pledged
mortgage securities are private mortgage pass-through securities whereby the
related credit risk of the underlying loans is borne by AAA-rated private
mortgage insurers or subordinated bonds within the related CMO series to which
the collateral is pledged. The Company has retained only $1.2 million of credit
risk in the form of subordinated bonds associated with these securities. The
weighted average effective interest rate for total Pledged CMO Collateral was
7.19 percent during the quarter ended March 31, 1999.
-8-
<PAGE> 9
NOTE 6 -- COLLATERALIZED MORTGAGE OBLIGATIONS
Each series of CMOs issued consists of various classes of bonds, most of which
have fixed rates of interest. Interest is payable monthly or quarterly at
specified rates for all classes. Typically, principal payments on each series
are made to each class in the order of their stated maturities so that no
payment of principal will be made on any class of bonds until all classes having
an earlier stated maturity have been paid in full. The components of CMOs along
with selected other information are summarized as follows (dollars in
thousands):
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
-------------- -----------------
<S> <C> <C>
CMOs $ 3,994,489 $ 4,513,522
Accrued interest payable 21,974 25,609
----------- -----------
Total obligation 4,016,463 4,539,131
Unamortized discount (14,747) (17,807)
----------- -----------
$ 4,001,716 $ 4,521,324
=========== ===========
Range of average interest rates 5.12% to 9.45% 5.22% to 9.45%
Range of stated maturities 2008 to 2028 2007 to 2028
Number of series 27 31
</TABLE>
The maturity of each CMO series is directly affected by the rate of principal
prepayments on the related Pledged CMO Collateral. Each series is also subject
to redemption, generally at the Company's option, provided that certain
requirements specified in the related indenture have been met (referred to as
"Clean-up Calls"); therefore, the actual maturity of any series is likely to
occur earlier than its stated maturity. The average effective interest rate for
all CMOs was 7.31 percent during the quarter ended March 31, 1999.
NOTE 7 -- DISCLOSURES REGARDING FAIR VALUES OF DEBT SECURITIES
Estimated fair values of debt securities have been determined using available
market information and appropriate valuation methodologies; however,
considerable judgment is required in interpreting market data to develop these
estimates. In addition, fair values fluctuate on a daily basis. Accordingly,
estimates presented herein are not necessarily indicative of the amounts that
could be realized in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on
estimated fair values.
The fair value of Agency Securities, Non-agency Securities (excluding mortgage
loans held for sale) and CMO investments were estimated using either (i) quoted
market prices when available, including quotes made by lenders in connection
with designating collateral for repurchase arrangements, or (ii) offer prices
for similar assets or market positions. The fair value of Pledged CMO Collateral
was based on projected cash flows, after payment on the related CMOs, determined
using market discount rates and prepayment assumptions. The maturity of mortgage
assets is directly affected by the rate of principal payments on the underlying
mortgage loans and, for Pledged CMO Collateral, Clean-up Calls of the remaining
CMOs outstanding.
-9-
<PAGE> 10
The following table summarizes fair value disclosures for available-for-sale
debt securities (in thousands):
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Fair
Basis Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
AS OF MARCH 31, 1999
Agency Securities:
FNMA/FHLMC:
Fixed-rate $1,100,612 $ 1,014 $ 4,261 $1,097,365
Medium-term 852,153 2,547 191 854,509
ARMs:
LIBOR/CMT 950,653 3,717 3,191 951,179
COFI 254,007 40 211 253,836
GNMA ARMs 2,099,033 7,842 641 2,106,234
Non-agency Securities:
Fixed-rate 27,645 657 -- 28,302
CMO collateral and investments 156,093 2,346 101 158,338
---------- ---------- ---------- ----------
$5,440,196 $ 18,163 $ 8,596 $5,449,763
========== ========== ========== ==========
AS OF DECEMBER 31, 1998
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 396,917 $ 3,466 $ 38 $ 400,345
Medium-term 317,544 862 373 318,033
LIBOR/CMT ARMs 632,624 667 6,935 626,356
GNMA ARMs 885,943 819 3,311 883,451
Non-agency Securities:
Fixed-rate 34,815 856 -- 35,671
CMO collateral and investments 190,916 2,927 158 193,685
---------- ---------- ---------- ----------
$2,458,759 $ 9,597 $ 10,815 $2,457,541
========== ========== ========== ==========
</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
Basis Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
AS OF MARCH 31, 1999
Pledged CMO Collateral $3,881,212 $ 2,735 $ 22,699 $3,861,248
Non-agency Securities:
Fixed-rate 96,251 2,121 -- 98,372
---------- ---------- ---------- ----------
$3,977,463 $ 4,856 $ 22,699 $3,959,620
========== ========== ========== ==========
AS OF DECEMBER 31, 1998
Pledged CMO Collateral $4,377,589 $ 3,286 $ 26,359 $4,354,516
========== ========== ========== ==========
</TABLE>
-10-
<PAGE> 11
Sales of released CMO collateral occasionally occur provided the collateral has
paid down to within 15 percent of its original issuance amounts. The following
table summarizes disclosures related to dispositions of debt securities (in
thousands):
<TABLE>
<CAPTION>
Quarter Ended March 31
----------------------
1999 1998
--------- --------
<S> <C> <C>
Sale of securities held available-for-sale:
Amortized cost $ 7,573 $651,473
Gains* 1,761 4,721
Redemption of callable agency notes and sale of
released CMO collateral held-to-maturity:
Amortized cost -- 5,022
Gains -- 471
</TABLE>
* Excludes net loss of $23,000 on disposition of remaining derivative
financial instruments held by the Company.
NOTE 8 -- COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is net income (loss) plus other comprehensive income
(loss), which, for the periods presented, consists of the change in unrealized
gain (loss) on debt securities classified as available-for-sale. The following
table provides information regarding comprehensive income (loss) for the periods
indicated (in thousands):
<TABLE>
<CAPTION>
Quarter Ended
March 31
--------------------
1999 1998
-------- --------
<S> <C> <C>
Net income $ 13,907 $ 35,070
Other comprehensive income (loss):
Unrealized gain (loss) on debt securities:
Change in unrealized gain (loss) during period 12,546 (55,770)
Reclassification adjustment for gain included in net income (1,761) (4,721)
-------- --------
Other comprehensive income (loss) 10,785 (60,491)
-------- --------
Comprehensive income (loss) $ 24,692 $(25,421)
======== ========
</TABLE>
NOTE 9 -- NET INTEREST INCOME ANALYSIS
The following table summarizes interest income and interest expense and average
effective interest rates for the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
Quarter Ended March 31
-------------------------------------------
1999 1998
-------------------- --------------------
Amount Average Amount Average
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ 47,312 5.78% $ 98,784 6.17%
CMO collateral and investments 77,030 7.20 94,235 7.18
-------- --------
Total interest income 124,342 193,019
-------- --------
Interest expense:
Short-term borrowings 33,914 4.95 99,736 5.63
CMOs 77,517 7.31 77,803 7.36
-------- --------
Total interest expense 111,431 177,539
-------- --------
Net interest $ 12,911 $ 15,480
======== ========
</TABLE>
-11-
<PAGE> 12
The following table summarizes increases (decreases) in interest income and
interest expense due to changes in interest rates versus changes in volume for
the quarter ended March 31, 1999 compared to the same period in 1998 (in
thousands):
<TABLE>
<CAPTION>
Rate* Volume* Total
-------- -------- --------
<S> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ (5,939) $(45,533) $(51,472)
CMO collateral and investments 196 (17,401) (17,205)
-------- -------- --------
Total interest income (5,743) (62,934) (68,677)
-------- -------- --------
Interest expense:
Short-term borrowings (10,697) (55,125) (65,822)
CMOs (540) 254 (286)
-------- -------- --------
Total interest expense (11,237) (54,871) (66,108)
-------- -------- --------
Net interest $ 5,494 $ (8,063) $ (2,569)
======== ======== ========
</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 10 -- STOCKHOLDER LITIGATION
During 1998 twenty-four purported class action lawsuits were filed against the
Company and certain of its officers alleging, among other things, that the
defendants violated federal securities laws by publicly issuing false and
misleading statements and omitting disclosure of material adverse information
regarding the Company's business during various periods between January 28, 1997
and July 24, 1998. The complaints claim that as a result of such alleged
improper actions, the market price of the Company's equity securities were
artificially inflated during that time period. The complaints seek monetary
damages in an undetermined amount. In March 1999 these actions were
consolidated. The date by which the Company is to respond has not yet run. The
Company believes it has meritorious defenses to the claims and intends to
vigorously defend the actions. Based on available information, management
believes the resolution of these suits will not have a material adverse effect
on the financial position of the Company.
-12-
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
OVERVIEW
Capstead Mortgage Corporation, a mortgage investment firm, earns income from
investing in mortgage assets on a leveraged basis and from other investment
strategies. In response to deteriorating market conditions, in June 1998 the
Company began restructuring its mortgage asset portfolios and in December 1998
closed the sale of its mortgage banking operations. The Company entered 1999
with substantial liquidity but diminished earning capacity. Since year-end, the
mortgage finance markets have generally improved with increasing market
liquidity, slowing prepayment rates and declining borrowing rates.
In early 1999, the Company began redeploying a portion of the proceeds from the
sale of its mortgage banking operations to support increased holdings of
mortgage-backed securities issued by government-sponsored entities, either
Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities"). Purchases of Agency
Securities totaled $3.3 billion during the quarter, increasing this portfolio to
$5.3 billion by quarter-end. Average holdings of Agency Securities were $3.2
billion in the first quarter and this portfolio is expected to average
approximately $5.2 billion in the second quarter. The Company's leverage ratio
(short-term borrowings to stockholders' equity, before other comprehensive
income adjustments) increased from 2.7:1 at year-end to 7.1:1 at March 31, 1999.
The Company's targeted leverage ratio is moderately higher than the quarter-end
ratio; therefore, the Company may modestly increase its portfolio of Agency
Securities in the future. The Company continues to evaluate a number of
opportunities to acquire or make strategic investments in a variety of real
estate-related investments and entities. However, the Company may conclude to
substantially limit its activities to investing in Agency Securities.
As of March 31, 1999, the Company had repurchased over 4.5 percent of its
outstanding shares of common stock and a more modest number of shares of its
$1.26 Cumulative Convertible Preferred Stock, Series B (the "Series B Preferred
Stock") since share repurchases began in December 1998. As the common stock
continues to sell below its book value, such repurchases may continue. Acquiring
common stock at prices below book value per share results in modest increases in
book value and net income per share. The Company averaged 60,138,000 common
shares outstanding for the quarter ending March 31, 1999 and ended the quarter
with 58,702,000 common shares outstanding.
MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities and other investments consist primarily of high quality
single-family residential mortgage-backed securities, most of which are Agency
Securities. Agency Securities have no foreclosure risk; however, the Company is
subject to reduced net interest margins during periods of rising short-term
interest rates or increasing prepayment rates (see "Effects of Interest Rate
Changes"). The Company may also invest in government-issued securities, commonly
referred to as U.S. Treasury notes or bonds. Non-agency securities consist of
(i) private mortgage pass-through securities whereby the related credit risk of
the underlying loans is borne by AAA-rated private mortgage insurers, (ii) other
AAA-rated private mortgage securities, or (iii) single-family residential
mortgage loans held for sale in connection with curtailed loan production
activities (together, "Non-agency Securities"). The Company classifies its
mortgage securities and other investments by interest rate characteristics of
the underlying loans or the securities themselves (see NOTE 4 to the
accompanying consolidated financial statements). Mortgage
-13-
<PAGE> 14
securities and other investments are financed under repurchase arrangements with
investment banking firms pursuant to which the portfolios are pledged as
collateral (see "Liquidity and Capital Resources").
The following yield and cost analysis illustrates changes during the quarter in
the Company's mortgage investment portfolio and its earnings capacity achieved
through the acquisition of additional securities and improving market
conditions:
<TABLE>
<CAPTION>
Average for the Quarter Ended
March 31, 1999 As of March 31, 1999
------------------------------ --------------------------------------------------
Lifetime
Actual Actual Premium Projected Prepayment
Basis Yield/Cost Runoff (Discount) Basis Yield/Cost Assumptions
----------- ---------- ------ ----------- ----------- ---------- -----------
* * ** **
<S> <C> <C> <C> <C> <C> <C> <C>
Agency securities:
FNMA/FHLMC:
Fixed-rate $ 590,551 6.31% 15% $ (3,284) $ 1,100,612 6.23% 10%
Medium-term 480,296 5.83 33 5,909 852,153 5.80 30
ARMs:
LIBOR/CMT 795,467 5.22 44 22,598 950,653 4.90 50
COFI 66,238 6.19 9 1,669 254,007 5.61 18
GNMA ARMs 1,269,977 5.67 33 33,472 2,099,033 5.45 30
----------- ---- ---- ----------- ----------- ---- ----
3,202,529 5.71 33 60,364 5,256,458 5.58 29
Non-agency securities:
Fixed-rate 74,313 8.24 50 167 123,896 8.14 50
Mortgage loans
held for sale 8,950 6.51 -- -- -- -- --
----------- ---- ---- ----------- ----------- ---- ----
3,285,792 5.77 33% $ 60,531 5,380,354 5.63 29%
==== =========== ====
Less short-term
borrowings 2,743,947 4.95 4,802,199 4.87
----------- ---- ----------- ----
Capital employed/
financing spread $ 541,845 0.82% $ 578,155 0.76%
=========== ==== =========== ====
Return on assets*** 1.62% 1.29%
</TABLE>
* Basis is the Company's investment before mark-to-market for securities
classified as available-for-sale.
** Projected yields are computed based on the Company's current lifetime
prepayment assumptions. Actual yields realized in future periods will
depend upon actual prepayments and any changes in prepayment assumptions.
The projected short-term borrowing rate reflects costs of borrowings as of
quarter-end.
*** The Company uses its excess capital to pay down short-term indebtedness.
Return on assets is calculated giving the benefit of the reduction in
interest costs from the use of capital, including excess capital currently
invested in these portfolios.
The Company acquired $722 million of fixed-rate, $575 million of medium-term,
$682 million of Fannie Mae/Freddie Mac ARM and $1.3 billion of Ginnie Mae ARM
Agency Securities during the current quarter, increasing its portfolio of Agency
Securities to $5.3 billion at March 31, 1999 from $2.2 billion at December 31,
1998. The Company also called for redemption four series of collateralized
mortgage obligations during the quarter returning $106 million of fixed-rate
mortgage loans to its Non-agency Securities portfolio. Investments in fixed-rate
mortgage securities, although higher in dollar terms, were little changed as a
percentage of total mortgage investments (22.7 percent at March 31, 1999
compared to 22.9 percent at year-end). Medium-term mortgage securities increased
to 15.9 percent at March 31, 1999 compared to 13.4 percent at year-end, while
ARM investments represented 61.5 percent at quarter-end down from 63.7 percent.
The Company's leverage ratio increased from 2.7:1 at year-end to 7.1:1 at March
31, 1999. The Company's targeted leverage ratio is moderately higher than the
quarter-end ratio; therefore, the Company may modestly increase its portfolio of
Agency Securities in the future.
-14-
<PAGE> 15
The premium paid for these portfolios, net of related amortization, increased to
$60.5 million at March 31, 1999 from $33.7 million at year-end while actually
declining as a percentage of these investments to 1.14 percent from 1.44
percent. This net premium paid is amortized to income as a yield adjustment
based on both actual prepayments and lifetime prepayment assumptions. Actual
prepayments declined throughout the quarter as mortgage interest rates
increased. Prepayments on Fannie Mae and Freddie Mac medium-term and
adjustable-rate ("ARM") Agency Securities declined from an annualized rate of
48.4 percent in December 1998 to 30.2 percent in March 1999. Prepayments on
Ginnie Mae ARMs declined from an annualized rate of 37.9 percent in December
1998 to 31.2 percent in March 1999. Should actual prepayments continue to trend
lower, the Company's lifetime prepayment assumptions may change, which could
have a positive effect on future yields. Based on current expectations, barring
an increase in short-term borrowing costs, the Company's overall financing
spread for the second quarter is expected to be approximately the same as was
achieved in the first quarter (see "Effects of Interest Rate Changes").
CMO COLLATERAL AND INVESTMENTS
The Company had been an active issuer of CMOs and other securities backed by
single-family jumbo-sized residential mortgage loans obtained through a mortgage
loan conduit business that the Company exited in 1995. Since then, the Company
has maintained finance subsidiaries with remaining capacity to issue CMOs and
other securitizations ("securitization shelves"). In an effort to recover costs
associated with these securitization shelves, and to potentially add to its CMO
administration activities, the Company from time to time purchases mortgage
loans from originators or conduits and issues CMOs or other securities backed by
these loans. The Company may or may not retain a significant residual economic
interest in these securitizations. In 1997 and 1998, the Company issued four
such CMOs totaling $2.2 billion. Also in 1998, in order to enhance its
liquidity, the Company issued a $345 million CMO backed by Non-agency
Securities.
The related credit risk of the mortgage loans collateralizing CMOs issued by the
Company is borne by AAA-rated private mortgage insurers or by subordinated bonds
within the related CMO series to which the collateral is pledged. The Company
has retained only $1.2 million of credit risk in the form of subordinated bonds
associated with these securities. The Company also retained residual interests
in certain of these securitizations primarily with the characteristics of
interest-only mortgage securities. Interest-only mortgage securities are
entitled to receive all or some portion of the interest stripped from the
mortgage loans underlying the securities. In lieu of issuing CMOs, the Company
had increased its CMO investments (defined as CMO collateral and investments,
net of related bonds) by acquiring interest-only mortgage securities issued by
other issuers, primarily Fannie Mae and Freddie Mac. In 1998 the Company
disposed a $1.0 billion interest-only mortgage securities portfolio at a
substantial loss and during the first quarter sold the remaining purchased
interest-only mortgage securities.
As of March 31, 1999, the Company's CMO investments had been reduced to $37.8
million, down from $50.0 million at December 31, 1998. Included in this net
investment are $12.1 million and $14.7 million of remaining CMO collateral
premiums and bond discounts, respectively.
-15-
<PAGE> 16
UTILIZATION OF CAPITAL AND POTENTIAL LIQUIDITY
The following table summarizes the Company's utilization of capital and
potential liquidity as of March 31, 1999 (in thousands):
<TABLE>
<CAPTION>
Capital Potential
Assets Borrowings Employed Liquidity
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Agency securities:
FNMA/FHLMC:
Fixed-rate $1,097,365 $1,087,975 $ 9,390 $ (1,562)
Medium-term 854,509 757,432 97,077 71,420
ARMs:
LIBOR/CMT 951,179 770,974 180,205 151,979
COFI 253,836 248,451 5,385 (245)
GNMA ARMs 2,106,234 1,937,367 168,867 106,166
Non-agency securities:
Fixed-rate 124,553 - 124,553 121,697
CMO collateral and investments 4,039,550 4,001,716 37,834 7,500
---------- ---------- ---------- ---------
$9,427,226 $8,803,915 623,311 456,955
========== ==========
Other assets, net of other liabilities 65,268 8,025**
---------- ---------
$ 688,579 $ 464,980
========== =========
</TABLE>
* Based on maximum borrowings available under existing uncommitted repurchase
arrangements considering the fair value of related collateral as of March
31, 1999 (see "Liquidity and Capital Resources").
** Represents unrestricted cash and cash equivalents.
STOCK REPURCHASES AND BOOK VALUES PER COMMON SHARE
In December 1998 the Company completed a previously authorized repurchase of 1
million shares of common stock at an average price of $4.10 per share (including
transaction costs). On February 4, 1999 the Company's board of directors
authorized the repurchase of up to an additional 6 million shares of its common
stock and up to 2 million shares of its Series B Preferred Stock. Subsequently
the Company repurchased, as of March 31, 1999, 1,759,600 shares of common stock
at an average price of $5.09 (including transaction costs) and 118,600 shares of
its Series B Preferred Stock at an average price of $11.99 (including
transaction costs) pursuant to this repurchase program. In early January another
85,583 shares were repurchased from employees at $4.12 per share in connection
with the lapsing of restrictions on stock awards with the December 1998 sale of
the mortgage banking operations.
Altogether the Company has repurchased over 4.5 percent of its outstanding
shares of common stock since the first share repurchases in December 1998. As
the common stock continues to sell below its book value, such repurchases may
continue. Acquiring common stock at prices below book value per share results in
modest increases in book value and net income per share. The Company averaged
60,138,000 common shares outstanding for the quarter ending March 31, 1999 and
ended the quarter with 58,702,000 common shares outstanding. Book values per
common share outstanding at the respective balance sheet dates were as follows:
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
-------------- -----------------
<S> <C> <C>
Calculated assuming liquidation of preferred stock* $8.30 $7.88
Calculated assuming redemption of preferred stock** 7.97 7.56
</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.
-16-
<PAGE> 17
Of the 41 cent increase in book value per common share during the quarter ended
March 31, 1999 (calculated assuming redemption of the Company's convertible
preferred stock), 18 cents was attributable to the improvement in unrealized
gains on securities held available-for-sale, 14 cents to undistributed income
and 9 cents to the repurchase of common shares.
RESULTS OF OPERATIONS
Comparative net operating results (interest income or fee revenues, net of
related interest expense and, in the case of mortgage banking and CMO
administration, related direct and indirect operating expenses) by source were
as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Quarter Ended
March 31
--------------------
1999 1998
-------- --------
<S> <C> <C>
Agency Securities $ 11,817 $ 8,137
Non-agency Securities 1,529 1,807
CMO collateral and investments (1,062) 4,424
-------- --------
Net margin on mortgage assets and other investments 12,284 14,368
Mortgage banking operations -- 14,845
Other operating revenue (expense):
Gain on sale of mortgage assets and derivative
financial instruments 1,738 6,869
CMO administration and other 1,470 829
Other operating expense (1,585) (1,841)
-------- --------
Net income $ 13,907 $ 35,070
======== ========
Net income per common share:
Basic $ 0.14 $ 0.50
Diluted 0.14 0.48
</TABLE>
Operating results for the quarter ended March 31, 1999 were substantially less
than results for the first quarter of 1998 which were achieved prior to a
substantial downsizing of the Company's mortgage asset portfolios begun in June
1998 in response to deteriorating market conditions that culminated in the sale
of the mortgage banking operations in the December 1998. The Company entered
1999 with substantial liquidity but diminished earning capacity. Since year-end,
the mortgage finance markets have generally improved with increasing market
liquidity, slowing prepayment rates and declining borrowing rates. In early
1999, the Company began redeploying a portion of the proceeds from the sale of
its mortgage banking operations to increase holdings of Agency Securities and
Non-agency Securities and invested its remaining excess capital and liquidity in
its mortgage investment portfolios dramatically reducing borrowing costs.
The earning capacity of the Company's mortgage asset portfolios are largely
dependent on the extent to which the Company invests its excess capital and
liquidity in these portfolios, the overall size of the portfolios and the
relationship between short- and long-term interest rates (the "yield curve").
The Company is evaluating a number of opportunities to redeploy some portion of
its excess capital into strategic investments in a variety of real
estate-related investments and entities, although there can be no assurance that
the Company will make any such investments. Additionally, a further steepening
of the yield curve, whether through higher long-term interest rates or lower
short-term interest rates, should improve the performance of the Company's
mortgage asset portfolios (see "Effects of Interest Rate Changes").
-17-
<PAGE> 18
Agency Securities contributed more to operating results during the first quarter
of 1999 than the same period in 1998 despite a lower average outstanding
portfolio due primarily to the investment of much of the Company's excess
liquidity in this portfolio and, to a lesser extent, due to a 31-basis point
increase in financing spreads to 76 basis points. On average, the Company
employed $470 million of its capital to the Agency Securities portfolio during
the current quarter compared to only $119 million during the same period in
1998. The average outstanding portfolio of $3.2 billion during the current
quarter was 44 percent lower than during the same period in 1998. Yields for
this portfolio averaged 5.71 percent during the current quarter compared to 6.06
percent during the same period in 1998, while average borrowing rates were
significantly lower at 4.95 percent compared to 5.61 percent during the same
period in 1998. Lower yields reflect (i) changes in portfolio mix (ii) lower
6-month London Interbank Offered Rate ("LIBOR") and 1-year U.S. Treasury rates
experienced during much of 1998 which contributed to declining yields on ARM
securities because underlying ARM loans reset periodically based on those
indices and (iii) increased lifetime prepayment assumptions currently in use for
amortizing purchased premiums.
Non-agency Securities contributed less to operating results during the first
quarter of 1999 than in the same period in 1998 due primarily to the investment
of some of the Company's excess liquidity in this portfolio. The average
outstanding portfolio was $83 million during the current quarter financed
entirely by equity, compared to $681 million during the same period in 1998
during which time only $6 million of capital was employed supporting this
portfolio. Since March 31, 1998 the size of this portfolio has declined because
of runoff, sales and a $345 million CMO issuance offset to a degree by CMO
redemptions. Average yields for this portfolio (calculated including mortgage
insurance costs) were 8.05 percent during the first quarter compared to 6.82
percent during the same period in 1998.
CMO collateral and investments contributed substantially less to operating
results during the first quarter of 1999 than the same period in 1998 primarily
because of the disposition of a $1 billion interest-only mortgage securities
portfolio in June 1998, subsequent sales of remaining purchased interest-only
mortgage securities and redemptions of CMOs, which have significantly diminished
the earning capacity of this portfolio. Without growth of this portfolio either
through the issuance of CMOs in which the Company retains residual interests, or
the acquisition of other CMO investments, this portfolio is not expected to
provide a positive return on capital employed in future periods.
The mortgage banking operations were sold in December 1998. At December 31, 1998
the Company had established an accrual of over $23 million for contract
settlement provisions and anticipated costs associated with exiting the mortgage
banking operations. During the first quarter of 1999, the Company settled
approximately $18 million of this liability including a $16 million prepayment
protection settlement payment and $1.3 million paid out of restricted cash for
pricing adjustments on mortgage servicing rights acquisition agreements assumed
by the buyer.
Operating expenses during the first quarter of 1999 were less than in the same
period in 1998 due to lower compensation costs and general and administrative
costs as a direct result of the sale of the mortgage banking operations, offset
by the elimination of allocations of certain of these costs to those operations.
Ongoing operating expenses are expected to be at a similar level as incurred in
the first quarter.
During the first quarter of 1999 the Company recorded gains of $1,752,000 on the
sale of its remaining $5.9 million of purchased interest-only mortgage
securities held as CMO investments and $9,000 on the sale of $1.6 million of
GNMA ARMs (this transaction was an accommodation to one of the Company's
dealers). A net loss of $23,000 was recorded in disposing of remaining
derivative financial instruments ("Derivatives") held in connection with the
mortgage banking operations. This compares to sales of mortgage assets totaling
$677 million during the same period of 1998 for gains of $5.3 million and $1.6
million earned writing call options on fixed-rate mortgage investments.
-18-
<PAGE> 19
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds include monthly principal and interest
payments on mortgage securities and other investments, short-term borrowings,
excess cash flows on CMO investments and proceeds from sales of mortgage assets.
In addition, the Company has substantial excess liquidity with the proceeds from
the 1998 restructuring of its mortgage asset portfolios and the sale of its
mortgage banking operations (see above "Financial Condition"), which have been
deployed to reduce short-term borrowings. The Company currently believes that
these funds are sufficient for the acquisition of mortgage assets, repayments on
short-term borrowings, the payment of cash dividends as required for Capstead's
continued qualification as a Real Estate Investment Trust ("REIT") and common
and preferred stock repurchases as described below. In addition, the liquidity
provided by the sale of the mortgage banking operations affords the Company the
opportunity to make strategic investments in a variety of real estate-related
investments and entities. There can be no assurances, however, that the Company
will make any such investments. It is the Company's policy to remain strongly
capitalized and conservatively leveraged.
Short-term borrowings are primarily made under repurchase arrangements. The
Company has uncommitted repurchase facilities with investment banking firms to
finance mortgage assets, subject to certain conditions. Interest rates on
borrowings under these facilities are based on overnight to 30-day London
Interbank Offered Rate ("LIBOR") rates. The terms and conditions of these
arrangements, including interest rates, are negotiated on a
transaction-by-transaction basis. Amounts available to be borrowed under these
arrangements are dependent upon the fair value of the securities pledged as
collateral which fluctuates with changes in interest rates and the securities'
credit quality. Because of the credit-worthiness of securities issued by
government-sponsored entities and the U.S. government, the Company has
concentrated its investments financed using repurchase arrangements on these
securities.
In February 1999 the Company's board of directors authorized the repurchase of
up to 6 million shares of common stock and up to 2 million shares of the Series
B Preferred Stock. As of March 31, 1999, 4.2 million and 1.9 million shares of
common and Series B Preferred Stock remained available for repurchase under this
program, respectively. The Company may continue to repurchase the shares in open
market transactions from time to time subject to the price of its securities and
alternative investment opportunities.
EFFECTS OF INTEREST RATE CHANGES
INTEREST RATE SENSITIVITY ON OPERATING RESULTS
The Company performs earnings sensitivity analysis using an income simulation
model to estimate the effects that specific interest rate changes will have on
future earnings. All mortgage assets and any Derivatives held are included in
this exercise. In addition, sensitivity of fee income to market interest rate
levels, such as those related to CMO administration, are included as well. The
model incorporates management assumptions regarding the level of prepayments on
mortgage assets for a given level of market rate changes using industry
estimates of prepayment speeds for various coupon segments. These assumptions
are developed through a combination of historical analysis and future expected
pricing behavior.
-19-
<PAGE> 20
As of March 31, 1999, 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* $ 24,822 $ 33,020 $14,148 $(23,704)
</TABLE>
* Note that the impact of actual or planned acquisitions of mortgage assets
subsequent to quarter-end (beyond acquisitions necessary to replace runoff)
and potential new business activities were not factored into the simulation
model for purposes of this disclosure.
Income simulation modeling is a primary tool used to assess the direction and
magnitude of changes in net margins on mortgage assets resulting from changes in
interest rates. Key assumptions in the model include prepayment rates on
mortgage assets, changes in market conditions, and management's financial
capital plans. These assumptions are inherently uncertain and, as a result, the
model cannot precisely estimate net margins or precisely predict the impact of
higher or lower interest rates on net margins. Actual results will differ from
simulated results due to timing, magnitude and frequency of interest rate
changes and other changes in market conditions, management strategies and other
factors.
GENERAL DISCUSSION OF EFFECTS OF INTEREST RATE CHANGES
Changes in interest rates may impact the Company's earnings in various ways. The
Company's earnings depend, in part, on the difference between the interest
received on mortgage securities and other investments, and the interest paid on
related short-term borrowings. The resulting spread may be reduced or even
eliminated in a rising short-term interest rate environment. Because a
substantial portion of the Company's mortgage investments are ARM mortgage
securities, the risk of rising short-term interest rates is generally offset to
some extent by increases in the rates of interest earned on the underlying ARM
loans, which reset periodically based on underlying indices (generally 6-month
LIBOR and 1-year U.S. Treasury rates). Since ARM loans generally limit the
amount of such increases during any single interest rate adjustment period and
over the life of the loan, interest rates on borrowings can rise to levels that
may exceed the interest rates on the underlying loans contributing to a lower or
even negative financing spreads. At other times, as seen in 1998, declines in
these indices may be greater than declines in the Company's borrowing rates
which are based on 30-day LIBOR, contributing to lower or even negative
financing spreads. The Company may invest in Derivatives from time to time,
specifically interest rate caps, as a hedge against rising interest rates on a
portion of its short-term borrowings. Interest rate caps generally increase in
value as related interest rates rise and decline in value when such rates fall.
Another effect of changes in interest rates is that, as long-term interest rates
decrease, the rate of prepayment of mortgage loans underlying mortgage
investments generally increases. To the extent the proceeds of prepayments on
mortgage investments cannot be reinvested at a rate of interest at least equal
to the rate previously earned on such investments, earnings may be adversely
affected. As seen in 1998 prolonged periods of high prepayments can
significantly reduce the expected life of mortgage investments; therefore, the
actual yields realized can be lower due to faster amortization of purchase
premiums. In addition, the rates of interest earned on ARM investments generally
will decline during periods of falling short-term interest rates as the
underlying ARM loans reset at lower rates.
Changes in interest rates also impact earnings recognized from CMO investments,
which have consisted primarily of interest-only mortgage securities and
fixed-rate CMO residuals (see above "Financial Condition"). The amount of income
that may be generated from interest-only mortgage securities is dependent upon
the rate of principal prepayments on the underlying mortgage collateral. If
mortgage
-20-
<PAGE> 21
interest rates fall significantly below interest rates on the collateral,
principal prepayments will increase, reducing or eliminating the overall return
on these investments. As seen in 1998 sustained periods of high prepayments can
result in losses. Conversely, if mortgage interest rates rise, interest-only
mortgage securities tend to perform favorably because underlying mortgage loans
will generally prepay at slower rates, thereby increasing overall returns. The
Company has disposed of substantially all interest-only mortgage securities in
connection with the 1998 restructuring of its mortgage asset portfolios.
CMO residuals behave similarly to interest-only mortgage securities. As seen in
1998 if mortgage interest rates fall, prepayments on the underlying mortgage
loans generally will be higher thereby reducing or even eliminating overall
returns on these investments. This is due primarily to the acceleration of the
amortization of bond discounts, a noncash item, as bond classes are repaid more
rapidly than originally anticipated. Conversely, if mortgage interest rates rise
significantly above interest rates on the collateral, principal prepayments will
typically diminish, improving the overall return on an investment in a
fixed-rate CMO residual because of an increase in time over which the Company
receives the larger positive interest spread.
The Company periodically sells mortgage assets. Such sales may become attractive
as values of mortgage assets fluctuate with changes in interest rates. At other
times, such as in 1998, it may become prudent to significantly downsize mortgage
asset portfolios, for example, to mitigate exposure to further declines in
mortgage interest rates. In either case, sales of mortgage assets may increase
income volatility because of the recognition of transactional gains or losses.
The Company supplements its business plan from time to time with Derivatives
held to help offset the effects of falling interest rates on the value of
certain assets, such as interest-only mortgage securities and mortgage servicing
rights. Historically, most Derivatives used by the Company have been interest
rate floors that generally decrease in value when interest rates rise and
increase in value when rates decline. The fair value of interest rate floors
will erode over time and, as seen in 1998, can also be impacted by other factors
such as changes in market demand for these instruments. Other Derivatives
acquired from time to time may include U.S. Treasury futures contracts and
options, written options on mortgage assets or various other Derivatives
available in the marketplace that are compatible with the Company's risk
management objectives. In instances where such Derivatives are accorded hedge
accounting treatment, changes in value adjust the basis of the assets hedged. In
instances where Derivatives are not accorded hedge accounting treatment, changes
in value are recorded in operating results as they occur, which can increase
income volatility. With the sale of the interest-only mortgage securities and
the mortgage banking operations, the Company has significantly reduced its
exposure to declining mortgage interest rates and therefore the use of
Derivatives to manage this exposure has been curtailed.
OTHER
IMPACT OF THE YEAR 2000
Many existing computer software programs use only two digits to identify the
year in date fields and, as such, could fail or create erroneous results by or
at the Year 2000. The Company utilizes a number of software systems to
administer securitizations and manage its mortgage assets. In addition, the
Company utilizes vendors in various capacities and interfaces with various
institutions. The Company is exposed to the risk that its systems and the
systems of its vendors and institutions it interfaces with are not Year 2000
compliant.
State of Readiness. The Company has made and will continue to make investments
in its software systems and applications to ensure the Company is Year 2000
compliant. The Company is also taking steps to ensure that the vendors it
utilizes and institutions that it interfaces with are also taking the
-21-
<PAGE> 22
necessary steps to become Year 2000 compliant. This process is expected to be
essentially complete by the end of the second quarter of 1999. In addition, with
the sale of the mortgage banking operations in December 1998, the Company has
built a completely new computer network that is considered to be Year 2000
compliant.
Costs. The financial costs of becoming Year 2000 compliant for the ongoing
operations of the Company, including the construction of the Company's new
computer network, have not and are not expected to exceed $300,000.
Risks and Contingency Planning. Although the Company expects that all its
systems and applications will be Year 2000 compliant per the above schedule well
prior to December 31, 1999, there can be no assurance that all of the vendors it
utilizes and institutions that it interfaces with will complete their compliance
efforts. The Company will continue to monitor their efforts in this regard and
is currently drafting contingency plans for all critical processes to help
ensure the impact on the Company's operations, or that of customers or vendors
will be minimized if an event of non-compliance occurs. These plans include
arranging for the use of other vendors or other methodologies and processes to
transact the Company's business. The effect of any such disruption to the
Company's operations is not presently determinable.
FORWARD LOOKING STATEMENTS
This document contains "forward-looking statements" (within the meaning of the
Private Securities Litigation Reform Act of 1995) that inherently involve risks
and uncertainties. The Company's actual results and liquidity can differ
materially from those anticipated in these forward-looking statements as a
result of unforeseen factors. These factors may include, but are not limited to,
changes in general economic conditions, the availability of suitable
investments, fluctuations in and market expectations for fluctuations in
interest rates and levels of mortgage prepayments, the effectiveness of risk
management strategies, the impact of leverage, liquidity of credit markets, Year
2000 compliance failures, increases in costs and other general competitive
factors.
-22-
<PAGE> 23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS
The information required by this Item is incorporated by reference to the
information included in Item 2. "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
PART II. -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
The following Exhibits are presented herewith:
Exhibit 11 - Computation of Earnings Per Share for the quarter ended March
31, 1999 and 1998.
Exhibit 12 - Capstead Mortgage Corporation and Subsidiaries Computation of
Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends.
Exhibit 27 - Financial Data Schedule (electronic filing only).
(b) Reports on Form 8-K:
Current Report on Form 8-K and Amendment No. 1 to Current Report on Form
8-K both dated December 31, 1998 to file the following:
Exhibit 2.1 - Asset Purchase Agreement dated as of December 10, 1998 by and
among Capstead Mortgage Corporation, Capstead Holdings, Inc. and Capstead
Inc. and Homecomings Financial Network, Inc.
Exhibit 10.33 - Purchase and Sale Agreement dated as of November 30, 1998
by and among Capstead Inc. and GMAC Mortgage Corporation.
Item 7. - Unaudited Pro Forma Financial Data - Unaudited Pro Forma
Condensed Statement of Operations for the Year Ended December 31, 1998.
-23-
<PAGE> 24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CAPSTEAD MORTGAGE CORPORATION
Date: May 6, 1999 By: /s/ RONN K. LYTLE
-------------------------------------
Ronn K. Lytle
Chairman and Chief Executive Officer
Date: May 6, 1999 By: /s/ ANDREW F. JACOBS
-------------------------------------
Andrew F. Jacobs
Executive Vice President - Finance,
Treasurer and Secretary
-24-
<PAGE> 25
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
11 Computation of Earnings Per Share for the quarter ended
March 31, 1999 and 1998.
12 Capstead Mortgage Corporation and Subsidiaries Computation of
Ratio of Earnings to Combined Fixed Charges and Preferred Stock
Dividends.
27 Financial Data Schedule (electronic filing only).
</TABLE>
<PAGE> 1
EXHIBIT 11
CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Quarter Ended
March 31
--------------------
1999 1998
-------- --------
<S> <C> <C>
BASIC:
Average number of common shares outstanding 60,138 59,594
======== ========
Net income $ 13,907 $ 35,070
Less cash dividends paid on convertible preferred stock:
Series A ($0.40 per share) (150) (160)
Series B ($0.315 per share) (5,437) (5,395)
Repurchase price in excess of recorded value (97) --
-------- --------
Net income available to common stockholders $ 8,223 $ 29,515
======== ========
Basic net income per common share $ 0.14 $ 0.50
======== ========
DILUTED:*
Average number of common shares outstanding 59,594
Assumed conversion of convertible preferred stock
Series A 827
Series B 12,416
Incremental shares calculated using the Treasury Stock method 555
--------
73,392
========
Net income $ 35,070
========
Diluted net income per common share $ 0.14 $ 0.48
======== ========
</TABLE>
* The Series A and B Preferred Stock was not considered convertible for
purposes of calculating diluted net income per common share for the quarter
ended March 31, 1999 because the effects of conversion were antidilutive.
<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>
Three Months Year Ended December 31
Ended ----------------------------------------------------------
March 31, 1999 1998 1997 1996 1995 1994
-------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Fixed charges $ 111,431 $ 673,233 $ 633,845 $ 598,312 $ 584,137 $ 474,844
Preferred stock dividends 5,684 22,342 25,457 36,356 39,334 38,876
--------- --------- --------- --------- --------- ---------
Combined fixed charges and
preferred stock dividends 117,115 695,575 659,302 634,668 623,471 513,720
Net income (loss) 13,907 (234,764) 159,926 127,228 77,359 85,579
--------- --------- --------- --------- --------- ---------
Total $ 131,022 $ 460,811 $ 819,228 $ 761,896 $ 700,830 $ 599,299
========= ========= ========= ========= ========= =========
Ratio of earnings to combined
fixed charges and preferred
stock dividends 1.12:1 0.66:1 1.24:1 1.20:1 1.12:1 1.17:1
========= ========= ========= ========= ========= =========
</TABLE>
(b) Computation of ratio of earnings to combined fixed charges and preferred
stock dividends (excluding CMO debt):
<TABLE>
<CAPTION>
Three Months Year Ended December 31
Ended ----------------------------------------------------------
March 31, 1999 1998 1997 1996 1995 1994
-------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Fixed charges $ 33,914 $ 332,985 $ 352,348 $ 283,974 $ 223,751 $ 139,188
Preferred stock dividends 5,684 22,342 25,457 36,356 39,334 38,876
--------- --------- --------- --------- --------- ---------
Combined fixed charges and
preferred stock dividends 39,598 355,327 377,805 320,330 263,085 178,064
Net income (loss) 13,907 (234,764) 159,926 127,228 77,359 85,579
--------- --------- --------- --------- --------- ---------
Total $ 53,505 $ 120,563 $ 537,731 $ 447,558 $ 340,444 $ 263,643
========= ========= ========= ========= ========= =========
Ratio of earnings to combined
fixed charges and preferred
stock dividends 1.35:1 0.34:1 1.42:1 1.40:1 1.29:1 1.48:1
========= ========= ========= ========= ========= =========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CAPSTEAD
MORTGAGE CORPORATION'S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED
MARCH31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 8,025
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 9,510,807
<CURRENT-LIABILITIES> 4,820,512
<BONDS> 4,001,716
0
197,099
<COMMON> 587
<OTHER-SE> 490,893
<TOTAL-LIABILITY-AND-EQUITY> 9,510,807
<SALES> 0
<TOTAL-REVENUES> 127,550
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 2,212
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 111,431
<INCOME-PRETAX> 13,907
<INCOME-TAX> 0
<INCOME-CONTINUING> 13,907
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,907
<EPS-PRIMARY> 0.14
<EPS-DILUTED> 0.14
</TABLE>
