<PAGE> 1
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
----- EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
----- EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ______________
COMMISSION FILE NUMBER: 1-8996
CAPSTEAD MORTGAGE CORPORATION
(Exact name of Registrant as specified in its Charter)
<TABLE>
<S> <C>
MARYLAND 75-2027937
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8401 N CENTRAL EXPRESSWAY, SUITE 800, DALLAS, TX 75225
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code (214) 874-2323
The Registrant meets the conditions set forth in General Instruction H(1)(a) and
(b) for Form 10-Q and is therefore filing this Form under the reduced disclosure
format.
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date.
Common Stock ($0.01 par value) 56,901,405 as of November 10, 1999
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<PAGE> 2
CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
INDEX
<TABLE>
<CAPTION>
PART I. -- FINANCIAL INFORMATION
PAGE
----
<S> <C>
ITEM 1. Financial Statements
Consolidated Balance Sheet -- September 30, 1999 and December 31, 1998................................. 3
Consolidated Statement of Operations -- Quarter and Nine Months Ended
September 30, 1999 and 1998.......................................................................... 4
Consolidated Statement of Cash Flows -- Nine Months Ended
September 30, 1999 and 1998.......................................................................... 5
Notes to Consolidated Financial Statements............................................................. 6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............................................. 14
ITEM 3. Qualitative and Quantitative Disclosure of Market Risk.................................... 24
PART II. -- OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K.......................................................... 24
SIGNATURES................................................................................................ 25
</TABLE>
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PART I. -- FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Mortgage securities and other investments $ 5,620,513 $ 2,369,602
CMO collateral and investments 3,443,774 4,571,274
------------ ------------
9,064,287 6,940,876
Prepaids, receivables and other 52,930 59,526
Restricted cash 7,686 26,500
Cash and cash equivalents 12,718 73,385
------------ ------------
$ 9,137,621 $ 7,100,287
============ ============
LIABILITIES
Short-term borrowings $ 5,097,265 $ 1,839,868
Collateralized mortgage obligations 3,412,512 4,521,324
Accounts payable and accrued expenses 19,867 58,894
------------ ------------
8,529,644 6,420,086
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value; 100,000 shares authorized:
$1.60 Cumulative Preferred Stock, Series A,
374 and 374 shares issued and outstanding
($6,134 aggregate liquidation preference) 5,228 5,228
$1.26 Cumulative Convertible Preferred Stock, Series B,
16,759 and 17,298 shares issued and outstanding
($190,717 aggregate liquidation preference) 187,181 193,196
Common stock - $0.01 par value; 100,000 shares authorized;
57,562 and 60,546 shares issued and outstanding 576 605
Paid-in capital 772,426 787,677
Undistributed loss (295,764) (305,287)
Accumulated other comprehensive loss (61,670) (1,218)
------------ ------------
607,977 680,201
------------ ------------
$ 9,137,621 $ 7,100,287
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------------- --------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Mortgage securities and other investments $ 84,092 $ 67,625 $ 209,554 $ 270,622
CMO collateral and investments 63,725 77,058 208,796 268,951
---------- ---------- ---------- ----------
Total interest income 147,817 144,683 418,350 539,573
---------- ---------- ---------- ----------
INTEREST AND RELATED EXPENSE:
Short-term borrowings:
Mortgage securities and other investments 67,746 68,834 161,987 252,673
CMO investments -- 325 -- 22,648
Collateralized mortgage obligations 64,309 92,914 209,741 254,667
Mortgage insurance and other 456 818 1,605 2,912
---------- ---------- ---------- ----------
Total interest and related expense 132,511 162,891 373,333 532,900
---------- ---------- ---------- ----------
Net margin on mortgage assets and
other investments 15,306 (18,208) 45,017 6,673
---------- ---------- ---------- ----------
NET MARGIN ON MORTGAGE BANKING OPERATIONS -- 13,215 -- 907
OTHER OPERATING REVENUE (EXPENSE):
Gain (loss) on sale of mortgage assets and related
derivative financial instruments -- (991) 1,738 (245,435)
Impairment on CMO investments -- (4,051) -- (4,051)
CMO administration and other 804 1,062 3,177 3,063
Other operating expense (1,588) (2,852) (4,820) (6,044)
---------- ---------- ---------- ----------
Total other operating revenue (expense) (784) (6,832) 95 (252,467)
---------- ---------- ---------- ----------
NET INCOME (LOSS) $ 14,522 $ (11,825) $ 45,112 $ (244,887)
========== ========== ========== ==========
Net income (loss) $ 14,522 $ (11,825) $ 45,112 $ (244,887)
Less cash dividends on preferred stock (5,543) (5,600) (16,952) (16,744)
---------- ---------- ---------- ----------
Net income (loss) available to common stockholders $ 8,979 $ (17,425) $ 28,160 $ (261,631)
========== ========== ========== ==========
NET INCOME (LOSS) PER COMMON SHARE:
Basic $ 0.16 $ (0.28) $ 0.48 $ (4.30)
Diluted 0.16 (0.28) 0.48 (4.30)
CASH DIVIDENDS PAID PER SHARE:
Common $ 0.180 $ -- $ 0.320 $ 1.000
Series A Preferred 0.400 0.400 1.200 1.200
Series B Preferred 0.315 0.315 0.945 0.945
</TABLE>
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 45,112 $ (244,887)
Noncash items:
Impairment on mortgage servicing rights and
CMO investments -- 199,615
Amortization of mortgage servicing rights and related costs -- 74,737
Amortization of discount and premium 34,397 121,023
Depreciation and other amortization 797 3,885
Gain on sale of financial instruments held to offset the effects of impairment -- (180,846)
Loss (gain) on sale of mortgage assets and derivative financial instruments (1,738) 271,552
Net change in prepaids, receivables, other assets, accounts payable
and accrued expenses (13,181) (8,133)
------------ ------------
Net cash provided by operating activities 65,387 236,946
------------ ------------
INVESTING ACTIVITIES:
Purchases of mortgage securities and other investments (4,317,389) (4,022,469)
Purchases of CMO collateral and investments -- (1,305,865)
Purchases of mortgage servicing rights -- (90,584)
Purchases of derivative financial instruments -- (76,243)
Principal collections on mortgage investments 1,010,216 1,778,149
Proceeds from sales of mortgage assets 114,763 5,032,829
Proceeds from sales and settlements of derivative financial instruments 12,595 299,547
CMO collateral:
Principal collections 955,346 771,098
Decrease in accrued interest receivable 7,151 6,015
Decrease in short-term investments 13,664 5,710
------------ ------------
Net cash provided (used) by investing activities (2,203,654) 2,398,187
------------ ------------
FINANCING ACTIVITIES:
Increase (decrease) in short-term borrowings 3,257,397 (3,192,851)
Increase in mortgage servicing acquisitions payable -- 27,569
Collateralized mortgage obligations:
Issuance of securities -- 1,494,853
Principal payments on securities (1,115,998) (886,019)
Decrease in accrued interest payable (6,915) (9,642)
Capital stock transactions (21,295) 50,042
Dividends paid (35,589) (77,602)
------------ ------------
Net cash provided (used) by financing activities 2,077,600 (2,593,650)
------------ ------------
Net change in cash and cash equivalents (60,667) 41,483
Cash and cash equivalents at beginning of period 73,385 17,377
------------ ------------
Cash and cash equivalents at end of period $ 12,718 $ 58,860
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE> 6
CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
NOTE 1 -- BUSINESS
Capstead Mortgage Corporation, a mortgage investment firm, earns income from
investing in mortgage assets on a leveraged basis and from other investment
strategies. In response to the lower long-term interest rate environment
experienced in 1998, the Company restructured its mortgage asset portfolios and
sold its mortgage banking operations, which created substantial liquidity.
Currently, the Company's primary focus is managing a portfolio of single-family
residential mortgage-backed securities issued by government-sponsored entities,
either Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities"). Short-term
borrowings and equity finance this portfolio. The Company presently intends to
continue to evaluate a number of possibilities to acquire or make strategic
investments in a variety of real estate-related investments and entities.
However, the Company may conclude to continue to substantially limit its
activities to investing in Agency Securities.
NOTE 2 -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the quarter and nine months ended September
30, 1999 are not necessarily indicative of the results that may be expected for
the calendar year ending December 31, 1999. For further information refer to the
consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended December 31, 1998.
Certain amounts for prior periods have been reclassified to conform to the
current year presentation.
NOTE 3 -- SHARE REPURCHASES AND DECLARATION OF COMMON STOCK DIVIDEND
On February 4, 1999 the Company's Board of Directors authorized the repurchase
of up to 6,000,000 shares of its common stock and up to 2,000,000 shares of its
$1.26 Cumulative Convertible Preferred Stock, Series B (the "Series B Preferred
Stock"). As of September 30, 1999, the Company had repurchased 2,900,000 shares
of common stock at an average price of $5.15 (including transaction costs) and
538,500 shares of the Series B Preferred Stock at an average price of $11.89
(including transaction costs) pursuant to this repurchase program. In December
1998 the Company completed a previously authorized repurchase of 1 million
shares of common stock at an average price of $4.10 per share (including
transaction costs). In early January 85,583 formerly restricted shares of common
stock were repurchased at $4.12 per share from employees in order to assist them
with meeting their federal income tax obligations resulting from the lapsing of
restrictions on stock awards with the December 1998 sale of the mortgage banking
operations. Altogether the Company has repurchased 6.5 percent of its
outstanding shares of common stock and 3.1 percent of the Series B Preferred
Stock since the first share repurchases in December 1998. All such repurchased
shares have been canceled and returned to authorized but unissued shares.
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<PAGE> 7
On October 20, 1999 the Board of Directors declared a second quarter dividend of
16 cents per common share, payable November 19 to stockholders of record as of
November 1, 1999.
NOTE 4 -- MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities investments and the related average effective interest rates
(calculated for the quarter then ended including mortgage insurance costs on
non-agency securities and excluding unrealized gains and losses) were as follows
(dollars in thousands):
<TABLE>
<CAPTION>
PURCHASE AVERAGE
PRINCIPAL PREMIUMS CARRYING AVERAGE EFFECTIVE
BALANCE (DISCOUNTS) BASIS AMOUNT COUPON RATE
------------ ------------ ------------ ------------ ------- ---------
* ** **
<S> <C> <C> <C> <C> <C> <C>
SEPTEMBER 30, 1999
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 1,082,366 $ (3,061) $ 1,079,305 $ 1,043,048 6.18% 6.23%
Medium-term 1,162,570 4,853 1,167,423 1,151,802 6.16 5.91
ARMs:
LIBOR/CMT 974,224 22,193 996,417 1,000,395 6.93 5.84
COFI 252,733 1,646 254,379 247,520 5.75 5.52
GNMA ARMs 2,022,276 27,606 2,049,882 2,041,562 6.25 5.66
------------ ------------ ------------ ------------ ------ ------
5,494,169 53,237 5,547,406 5,484,327 6.31 5.85
Non-agency securities 135,373 373 135,746 136,186 8.30 8.07
------------ ------------ ------------ ------------ ------ ------
$ 5,629,542 $ 53,610 $ 5,683,152 $ 5,620,513 6.36% 5.90%
============ ============ ============ ============ ====== ======
DECEMBER 31, 1998
Agency and U.S. Treasury
Securities:
U.S. Treasury notes $ -- $ -- $ -- $ -- --% 4.68%
FNMA/FHLMC:
Fixed-rate 397,648 (731) 396,917 400,345 6.50 6.42
Medium-term 313,947 3,597 317,544 318,033 6.60 5.67
LIBOR/CMT ARMs 616,274 16,350 632,624 626,356 7.49 5.24
GNMA ARMs 871,308 14,635 885,943 883,451 6.75 5.76
------------ ------------ ------------ ------------ ------ ------
2,199,177 33,851 2,233,028 2,228,185 6.89 5.72
Non-agency securities 140,718 (157) 140,561 141,417 7.22 7.23
------------ ------------ ------------ ------------ ------ ------
$ 2,339,895 $ 33,694 $ 2,373,589 $ 2,369,602 6.91% 5.81%
============ ============ ============ ============ ====== ======
</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.
The Company classifies its mortgage securities by interest rate characteristics
of the underlying single-family residential mortgage loans. Fixed-rate mortgage
securities either (i) have fixed rates of interest for their entire terms, (ii)
have an initial fixed-rate period of 10 years after origination and then adjust
annually based on a specified margin over 1-year U.S. Treasury Securities
("1-year Treasuries"), or (iii) were previously classified as medium-term and
have adjusted to a fixed rate for the remainder of their terms. Medium-term
mortgage securities either (i) have an initial fixed-rate period of 3 or 5 years
after origination and then adjust annually based on a specified margin over
1-year Treasuries, (ii) have initial interest rates that adjust one time,
approximately 5 years following origination of the mortgage loan, based on a
specified margin over Fannie Mae yields for 30-year, fixed-rate commitments at
the time of adjustment, or (iii) fixed-rate mortgage securities that have
expected weighted average lives of 5 years or
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<PAGE> 8
less. Adjustable-rate mortgage securities either (i) adjust semiannually based
on a specified margin over the 6-month London Interbank Offered Rate ("LIBOR"),
(ii) adjust annually based on a specified margin over 1-year Treasuries ("CMT"),
(iii) adjust monthly based on a specific margin over the Cost of Funds Index as
published by the Eleventh District Federal Reserve Bank ("COFI"), or (iv) were
previously classified as medium-term and have begun adjusting annually based on
a specified margin over 1-year Treasuries.
Agency and U.S. Treasury securities consist of Agency Securities and U.S.
government-issued fixed-rate securities, commonly referred to as U.S. Treasury
notes or bonds (collectively, "Agency and U.S. Treasury Securities"). Agency
Securities have no foreclosure risk. Non-agency securities consist of private
mortgage pass-through securities backed primarily by single-family jumbo-sized
residential mortgage loans whereby the related credit risk of the underlying
loans is borne by AAA-rated private mortgage insurers, and other AAA-rated
private mortgage securities (together, "Non-agency Securities"). At December 31,
1998 Non-Agency Securities also included mortgage loans held for sale in
connection with curtailed mortgage production activities. The maturity of
mortgage-backed securities is directly affected by the rate of principal
prepayments on the underlying loans.
NOTE 5 -- CMO COLLATERAL AND INVESTMENTS
Collateralized mortgage obligation ("CMO") collateral consists of (i)
fixed-rate, medium-term and adjustable-rate mortgage securities collateralized
by single-family residential mortgage loans and (ii) related short-term
investments, both pledged to secure CMO borrowings ("Pledged CMO Collateral").
CMO investments have included investments in interest-only mortgage securities
and investments in other CMO securities such as principal-only mortgage
securities. Interest-only mortgage securities are entitled to receive 100
percent of coupon interest stripped from pools of mortgage loans. The components
of CMO collateral and investments are summarized as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ ------------------
<S> <C> <C>
Pledged CMO Collateral:
Pledged mortgage securities $ 3,408,505 $ 4,507,337
Short-term investments 1,215 14,879
Accrued interest receivable 20,210 27,361
------------------ ------------------
3,429,930 4,549,577
Unamortized premium 10,614 11,830
------------------ ------------------
3,440,544 4,561,407
CMO investments 3,230 9,867
------------------ ------------------
$ 3,443,774 $ 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 $1.1 million of credit
risk in the form of subordinated bonds associated with these securities. The
weighted average effective interest rate for total Pledged CMO Collateral was
7.22 percent during the quarter ended September 30, 1999.
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<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>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
<S> <C> <C>
CMOs $ 3,406,115 $ 4,513,522
Accrued interest payable 18,694 25,609
------------- -------------
Total obligation 3,424,809 4,539,131
Unamortized discount (12,297) (17,807)
------------- -------------
$ 3,412,512 $ 4,521,324
============= =============
Range of average interest rates 5.16% to 9.45% 5.22% to 9.45%
Range of stated maturities 2008 to 2028 2007 to 2028
Number of series 24 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 7.34 percent during the quarter ended September 30, 1999.
NOTE 7 -- DISCLOSURES REGARDING FAIR VALUES OF DEBT SECURITIES
Estimated fair values of debt securities have been determined using available
market information and appropriate valuation methodologies; however,
considerable judgment is required in interpreting market data to develop these
estimates. In addition, fair values fluctuate on a daily basis. Accordingly,
estimates presented herein are not necessarily indicative of the amounts that
could be realized in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on
estimated fair values.
The fair value of Agency Securities, Non-agency Securities (excluding mortgage
loans held for sale) and CMO investments were estimated using either (i) quoted
market prices when available, including quotes made by lenders in connection
with designating collateral for repurchase arrangements, or (ii) offer prices
for similar assets or market positions. The fair value of Pledged CMO Collateral
was based on projected cash flows, after payment on the related CMOs, determined
using market discount rates and prepayment assumptions. The maturity of mortgage
assets is directly affected by the rate of principal payments on the underlying
mortgage loans and, for Pledged CMO Collateral, Clean-up Calls of the remaining
CMOs outstanding.
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<PAGE> 10
The following tables summarize fair value disclosures for available-for-sale
debt securities (in thousands):
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
BASIS GAIN LOSS VALUE
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
AS OF SEPTEMBER 30, 1999
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 1,079,305 $ 299 $ 36,556 $ 1,043,048
Medium-term 1,167,423 27 15,648 1,151,802
ARMs:
LIBOR/CMT 996,417 5,877 1,899 1,000,395
COFI 254,379 -- 6,859 247,520
GNMA ARMs 2,049,882 689 9,009 2,041,562
------------ ------------ ------------ ------------
5,547,406 6,892 69,971 5,484,327
Non-agency Securities 31,812 440 -- 32,252
CMO collateral and investments 114,191 1,095 126 115,160
------------ ------------ ------------ ------------
$ 5,693,409 $ 8,427 $ 70,097 $ 5,631,739
============ ============ ============ ============
AS OF DECEMBER 31, 1998
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 396,917 $ 3,466 $ 38 $ 400,345
Medium-term 317,544 862 373 318,033
LIBOR/CMT ARMs 632,624 667 6,935 626,356
GNMA ARMs 885,943 819 3,311 883,451
------------ ------------ ------------ ------------
2,233,028 5,814 10,657 2,228,185
Non-agency Securities 34,815 856 -- 35,671
CMO collateral and investments 190,916 2,927 158 193,685
------------ ------------ ------------ ------------
$ 2,458,759 $ 9,597 $ 10,815 $ 2,457,541
============ ============ ============ ============
</TABLE>
With substantial liquidity as of September 30, 1999, the Company currently has
the ability to hold mortgage assets for the foreseeable future and, therefore,
does not currently expect to realize losses on security sales. Liquidity is
defined as surplus capital available for the support and acquisition of mortgage
assets and other investments or activities.
Held-to-maturity debt securities consist of Pledged CMO Collateral and
collateral released from the related CMO indentures pursuant to Clean-up Calls
and held as Non-agency Securities. The following table summarizes fair value
disclosures for debt securities held-to-maturity (in thousands):
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
BASIS GAIN LOSS VALUE
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
AS OF SEPTEMBER 30, 1999
Non-agency Securities $ 103,934 $ 2,212 $ -- $ 106,146
Pledged CMO Collateral 3,328,614 1,904 19,259 3,311,259
------------ ------------ ------------ ------------
$ 3,432,548 $ 4,116 $ 19,259 $ 3,417,405
============ ============ ============ ============
AS OF DECEMBER 31, 1998
Pledged CMO Collateral $ 4,377,589 $ 3,286 $ 26,359 $ 4,354,516
============ ============ ============ ============
</TABLE>
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<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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
----------------------------- -----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sale of securities held available-for-sale:
Amortized cost $ -- $ 1,523,853 $ 7,753 $ 4,790,144
Gains (losses)* -- 22,286 1,761 (254,646)
Sale of released CMO collateral held-to-maturity:
Amortized cost -- -- -- 5,022
Gains -- -- -- 471
</TABLE>
* Excludes a first quarter 1999 loss of $23,000 on disposition of remaining
derivative financial instruments held by the Company.
NOTE 8 -- COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is net income (loss) plus other comprehensive income
(loss), which, for the periods presented, consists of the change in unrealized
gain (loss) on debt securities classified as available-for-sale. The following
table provides information regarding comprehensive income (loss) for the periods
indicated (in thousands):
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------------- --------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net income (loss) $ 14,522 $ (11,825) $ 45,112 $ (244,887)
---------- ---------- ---------- ----------
Other comprehensive income (loss):
Unrealized gain (loss) on debt securities:
Change in unrealized gain (loss) during period (23,141) 41,445 (58,691) (167,103)
Reclassification adjustment for (gain)
loss included in net income (loss) -- (22,286) (1,761) 254,646
---------- ---------- ---------- ----------
Other comprehensive income (loss) (23,141) 19,159 (60,452) 87,543
---------- ---------- ---------- ----------
Comprehensive income (loss) $ (8,619) $ 7,334 $ (15,340) $ (157,344)
========== ========== ========== ==========
</TABLE>
NOTE 9 -- NET INTEREST INCOME ANALYSIS
The following tables summarize interest income, interest expense and average
effective interest rates for the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
QUARTER ENDED SEPTEMBER 30
---------------------------------------------------------
1999 1998
-------------------------- --------------------------
AMOUNT AVERAGE AMOUNT AVERAGE
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ 84,092 5.90% $ 67,625 5.53%
CMO collateral and investments 63,725 7.22 77,058 7.10
---------- ----------
Total interest income 147,817 144,683
---------- ----------
Interest expense:
Short-term borrowings 67,746 5.19 69,159 5.58
CMOs 64,309 7.34 92,914 8.54
---------- ----------
Total interest expense 132,055 162,073
---------- ----------
Net interest $ 15,762 $ (17,390)
========== ==========
</TABLE>
-11-
<PAGE> 12
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30
--------------------------------------------------------
1999 1998
------------------------- -------------------------
AMOUNT AVERAGE AMOUNT AVERAGE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ 209,554 5.80% $ 270,622 5.92%
CMO collateral and investments 208,796 7.16 268,951 7.26
---------- ----------
Total interest income 418,350 539,573
---------- ----------
Interest expense:
Short-term borrowings 161,987 5.01 275,321 5.57
CMOs 209,741 7.25 254,667 7.78
---------- ----------
Total interest expense 371,728 529,988
---------- ----------
Net interest $ 46,622 $ 9,585
========== ==========
</TABLE>
The following tables summarize 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>
QUARTER ENDED SEPTEMBER 30, 1999
------------------------------------
RATE* VOLUME* TOTAL
-------- -------- --------
<S> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ 4,941 $ 11,526 $ 16,467
CMO collateral and investments 1,315 (14,648) (13,333)
-------- -------- --------
Total interest income 6,256 (3,122) 3,134
-------- -------- --------
Interest expense:
Short-term borrowings (5,076) 3,663 (1,413)
CMOs (11,972) (16,633) (28,605)
-------- -------- --------
Total interest expense (17,048) (12,970) (30,018)
-------- -------- --------
Net interest $ 23,304 $ 9,848 $ 33,152
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1999
------------------------------------------
RATE* VOLUME* TOTAL
---------- ---------- ----------
<S> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ (5,380) $ (55,688) $ (61,068)
CMO collateral and investments (3,727) (56,428) (60,155)
---------- ---------- ----------
Total interest income (9,107) (112,116) (121,223)
---------- ---------- ----------
Interest expense:
Short-term borrowings (25,678) (87,656) (113,334)
CMOs (16,369) (28,557) (44,926)
---------- ---------- ----------
Total interest expense (42,047) (116,213) (158,260)
---------- ---------- ----------
Net interest $ 32,940 $ 4,097 $ 37,037
========== ========== ==========
</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 11 -- 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
-12-
<PAGE> 13
the Company's business during various periods between January 28, 1997 and July
24, 1998. The complaints claim that as a result of such alleged improper
actions, the market prices of the Company's equity securities were artificially
inflated during that time period. The complaints seek monetary damages in an
undetermined amount. In March 1999 these actions were consolidated. The date by
which the Company is to respond has not yet run. The Company believes it has
meritorious defenses to the claims and intends to vigorously defend the actions.
Based on available information, management believes the resolution of these
suits will not have a material adverse effect on the financial position of the
Company.
-13-
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
OVERVIEW
Capstead Mortgage Corporation, a mortgage investment firm, earns income from
investing in mortgage assets on a leveraged basis and from other investment
strategies. In response to the lower long-term interest rate environment
experienced in 1998, the Company restructured its mortgage asset portfolios and
sold its mortgage banking operations, which substantially increased the
Company's liquidity. Currently, the Company's primary focus is managing a
portfolio of single-family residential mortgage-backed securities issued by
government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae
("Agency Securities"). This portfolio is financed by short-term borrowings and
equity. After acquiring $3.3 billion of Agency Securities during the first
quarter of 1999, the Company increased its portfolio of Agency Securities only
modestly during the second and third quarters to $5.5 billion as of September
30, 1999. In the fourth quarter, the Company currently expects to maintain its
Agency Securities portfolio at approximately the same level. The Company's
leverage ratio (short-term borrowings to stockholders' equity, before other
comprehensive income adjustments) increased from 2.7:1 at year-end to 7.6:1 at
September 30, 1999.
Prepayments of mortgage loans underlying the Company's mortgage assets have
declined considerably during 1999 because of higher mortgage interest rates.
Lower prepayment levels improve yields on the Company's mortgage assets by
allowing related purchase premiums to be expensed to earnings over a longer
period of time. The Company currently expects prepayments to decline further in
the fourth quarter because of higher prevailing mortgage rates and seasonal
factors. In addition to benefiting from lower prepayments, yields are currently
expected to improve in future quarters as interest rates on mortgage loans
underlying the Company's adjustable-rate mortgage ("ARM") securities reset to
levels more reflective of the current interest rate environment. For example, if
interest rates stabilize at current levels, yields on the Company's ARM
securities could improve as much as 40 basis points over the next 12 months.
Conversely, if interest rates decline from current levels, such yield
improvement will likely not be achieved (see "Effects of Interest Rate
Changes"). ARM securities represent approximately 59 percent of the Company's
mortgage investment portfolios as of September 30, 1999.
The Company's borrowing rates have been over one-half of one percentage point
lower during 1999 than in the comparable period of 1998. However, the Federal
Reserve increased short-term interest rates by one-quarter of one percent at
both its June 29 and August 24, 1999 meetings and may increase rates further,
perhaps in the fourth quarter. If short-term borrowing rates continue to rise,
improving mortgage asset yields over the next 12 months would not fully keep
pace and net interest margins would decline (see "Effects of Interest Rate
Changes").
As of September 30, 1999, the Company had repurchased 6.5 percent of its
outstanding shares of common stock and 3.1 percent of its $1.26 Cumulative
Convertible Preferred Stock, Series B (the "Series B Preferred Stock") since
share repurchases began in December 1998. As the common stock continues to sell
below its book value, such repurchases may continue. Acquiring common stock at
prices below book value per share results in modest increases in book value per
share and net income per share.
Liquidity, which is defined as surplus capital available for the support and
acquisition of mortgage assets and other investments or activities, fluctuates
with, among other things, the size and fair value of the Company's mortgage
asset portfolios. Since year-end, stock repurchases, acquisitions of mortgage
assets
-14-
<PAGE> 15
and a decline in fair value of the Company's portfolios as a result of higher
interest rates have led to a decline in the Company's liquidity. However,
liquidity at quarter-end remains substantial affording the Company the ability
to maintain its mortgage asset portfolios at current levels for the foreseeable
future and to make additional investments. The Company presently intends to
continue to evaluate a number of possibilities to acquire or make strategic
investments in a variety of real estate-related investments and entities.
However, the Company may conclude to substantially limit its activities to
investing in Agency Securities.
MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage securities and other investments consist primarily of high quality
single-family residential mortgage-backed securities, most of which are Agency
Securities. Agency Securities have no foreclosure risk; however, the Company is
subject to reduced net interest margins during periods of rising short-term
interest rates or increasing prepayment rates (see "Effects of Interest Rate
Changes"). The Company may also invest in government-issued securities, commonly
referred to as U.S. Treasury notes or bonds. Non-agency securities consist of
private mortgage pass-through securities whereby the related credit risk of the
underlying loans is borne by AAA-rated private mortgage insurers, and other
AAA-rated private mortgage securities (together, "Non-agency Securities"). The
Company classifies its mortgage securities and other investments by interest
rate characteristics of the underlying loans or the securities themselves (see
NOTE 4 to the accompanying consolidated financial statements). Mortgage
securities and other investments are financed under repurchase arrangements with
investment banking firms pursuant to which specific securities held within the
portfolios are pledged as collateral (see "Liquidity and Capital Resources").
The following yield and cost analysis illustrates results achieved during the
most recent quarter for each component of the Company's mortgage investment
portfolio and its currently projected fourth quarter earnings capacity (see
footnotes below regarding assumptions used to develop projected asset yield and
borrowing rate information):
<TABLE>
<CAPTION>
AVERAGE FOR THE QUARTER ENDED AS OF SEPTEMBER 30, 1999
SEPTEMBER 30, 1999 ------------------------------ PROJECTED
----------------------------------------- PURCHASE FOURTH LIFETIME
ACTUAL ACTUAL PREMIUMS QUARTER PREPAYMENT
BASIS YIELD/COST RUNOFF (DISCOUNTS) BASIS YIELD/COST ASSUMPTIONS
------------ ---------- ------------ ------------ ------------ ---------- -----------
* * **
Agency Securities:
FNMA/FHLMC:
<S> <C> <C> <C> <C> <C> <C> <C>
Fixed-rate $ 1,087,491 6.23% 8% $ (3,061) $ 1,079,305 6.26% 8%
Medium-term 1,212,721 5.91 16 4,853 1,167,423 5.95 20
ARMs:
LIBOR/CMT 972,355 5.84 32 22,193 996,417 6.04 40
COFI 262,185 5.52 19 1,646 254,379 5.54 18
GNMA ARMs 2,021,036 5.66 24 27,606 2,049,882 5.83 25
------------ ------ ------------ ------------ ------------ ------ -----------
5,555,788 5.85 21 53,237 5,547,406 5.97 23
Non-agency Securities 134,633 8.07 41 373 135,746 7.77 45
------------ ------ ------------ ------------ ------------ ------ -----------
5,690,421 5.90 21% $ 53,610 5,683,152 6.01 24%
============ ============ ===========
Less short-term
borrowings*** 5,118,540 5.19 5,097,265 5.39
------------ ------ ------------ ------
Capital employed/
financing spread $ 571,881 0.71% $ 585,887 0.62%
============ ====== ============ ======
Return on assets**** 1.14% 1.07%
</TABLE>
-15-
<PAGE> 16
* Basis is the Company's investment before mark to market, which
includes unamortized purchase premiums and discounts.
** Projected fourth quarter yields reflect anticipated changes in
portfolio composition, ARM security coupon resets and lifetime
prepayment assumptions as adjusted for expected prepayments over the
next 3 months. Actual yields realized in future periods will largely
depend upon (a) changes in portfolio composition, (b) ARM security
coupon resets, (c) actual prepayments and (d) any changes in lifetime
prepayment assumptions.
*** Projected fourth quarter borrowing rates reflect the full impact of
the June and August Federal Reserve tightenings and may increase
further depending largely upon future actions by the Federal Reserve
to increase short-term interest rates.
**** The Company uses its liquidity to pay down short-term indebtedness.
Return on assets is calculated assuming the use of this liquidity to
reduce borrowing costs.
The Company acquired $739 million of fixed-rate, $1.0 billion of medium-term,
$951 million of Fannie Mae/Freddie Mac ARM and $1.6 billion of Ginnie Mae ARM
Agency Securities during the nine months ended September 30, 1999, increasing
its portfolio of Agency Securities to $5.5 billion at September 30, 1999 from
$2.2 billion at December 31, 1998 (all but $979 million of these securities were
acquired in the first quarter of 1999). The Company currently expects to
continue to maintain this portfolio at this level in the fourth quarter. The
Company also called for redemption six series of collateralized mortgage
obligations in 1999 returning $157 million of fixed- and adjustable-rate
mortgage loans to its Non-agency Securities portfolio. Investments in fixed-rate
mortgage securities, although higher in dollar terms, were slightly lower as a
percent of total mortgage investments (20.8 percent at September 30, 1999
compared to 22.9 percent at December 31, 1998). Medium-term mortgage securities
increased to 20.5 percent at September 30, 1999 compared to 13.4 percent at
December 31, 1998, while ARM investments declined to 58.7 percent at quarter-end
from 63.7 percent at year-end. The Company's leverage ratio increased to 7.6:1
at September 30, 1999 from 2.7:1 at December 31, 1998.
The unamortized net premium paid for these portfolios (referred to as "purchase
premiums (discounts)") increased to $53.6 million at September 30, 1999 from
$33.7 million at December 31, 1998, while actually declining as a percentage of
related unpaid principal balances to 0.95 percent from 1.44 percent at year-end.
Purchase premiums (discounts) are amortized to income as yield adjustments based
on both actual prepayments and lifetime prepayment assumptions. Actual
prepayments have declined throughout 1999 as mortgage interest rates increased.
Prepayments on Fannie Mae and Freddie Mac medium-term and adjustable-rate Agency
Securities declined to an annualized rate of 22.0 percent in September 1999 from
48.4 percent in December 1998. Prepayments on Ginnie Mae ARMs declined to an
annualized rate of 21.3 percent in September 1999, from 37.9 percent in December
1998. The Company currently expects prepayments to decline further in the fourth
quarter because of higher prevailing mortgage rates and seasonal factors. In
addition, yields on ARM securities are expected to improve over the next 12
months as interest rates on mortgage loans underlying these securities reset to
levels more reflective of the current interest rate environment (see "Overview"
above and "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
-16-
<PAGE> 17
totaling $2.2 billion. Also in 1998, in order to enhance its liquidity, the
Company issued a $345 million CMO backed by Non-agency Securities. No CMOs have
been issued in 1999.
The related credit risk of the mortgage loans collateralizing CMOs issued by the
Company is borne by AAA-rated private mortgage insurers or by subordinated bonds
within the related CMO series to which the collateral is pledged. The Company
has retained only $1.1 million of credit risk in the form of subordinated bonds
associated with these securities. The Company also retained residual interests
in certain of these securitizations primarily with the characteristics of
interest-only mortgage securities. Interest-only mortgage securities are
entitled to receive all or some portion of the interest stripped from the
mortgage loans underlying the securities. In lieu of issuing CMOs, the Company
had increased its CMO investments (defined as CMO collateral and investments,
net of related bonds) by acquiring interest-only mortgage securities issued by
other issuers, primarily Fannie Mae and Freddie Mac. In the second quarter of
1998 the Company disposed of a $1.0 billion interest-only mortgage securities
portfolio at a substantial loss and during the first quarter of 1999 sold its
remaining purchased interest-only mortgage securities.
As of September 30, 1999, the Company's CMO investments had been reduced to
$31.3 million, down from $50.0 million at December 31, 1998. Included in this
net investment are $10.6 million and $12.3 million of the remaining CMO
collateral premiums and bond discounts, respectively. Similar to purchase
premiums on the Company's mortgage investments, CMO collateral premiums and bond
discounts, along with most of remaining CMO investments, are amortized to income
as CMO collateral yield or bond expense adjustments based on both actual
prepayments and lifetime prepayment assumptions (see "Effects of Interest Rate
Changes").
UTILIZATION OF CAPITAL AND LIQUIDITY
The following table summarizes the Company's utilization of capital and
liquidity as of September 30, 1999 (in thousands):
<TABLE>
<CAPTION>
CAPITAL
ASSETS BORROWINGS EMPLOYED LIQUIDITY
---------- ---------- ---------- ----------
*
<S> <C> <C> <C> <C>
Agency Securities:
FNMA/FHLMC:
Fixed-rate $1,043,048 $ 984,340 $ 58,708 $ 33,166
Medium-term 1,151,802 1,068,220 83,582 49,103
ARMs:
LIBOR/CMT 1,000,395 888,908 111,487 81,709
COFI 247,520 240,785 6,735 (707)
GNMA ARMs 2,041,562 1,915,012 126,550 65,870
---------- ---------- ---------- ----------
5,484,327 5,097,265 387,062 229,141
Non-agency Securities 136,186 -- 136,186 132,862
CMO collateral and investments 3,443,774 3,412,512 31,262 --
---------- ---------- ---------- ----------
$9,064,287 $8,509,777 554,510 362,003
========== ==========
Other assets, net of other liabilities 53,467 12,718**
---------- ----------
$ 607,977 $ 374,721
========== ==========
</TABLE>
* Based on additional borrowings available under existing uncommitted
repurchase arrangements considering the size and fair values of the
Company's mortgage asset portfolios as of September 30, 1999 (see
"Liquidity and Capital Resources").
** Represents unrestricted cash and cash equivalents.
-17-
<PAGE> 18
STOCK REPURCHASES AND BOOK VALUES PER COMMON SHARE
On February 4, 1999 the Company's 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. As of September 30, 1999, the Company had repurchased
2,900,000 shares of common stock at an average price of $5.15 (including
transaction costs) and 538,500 shares of the Series B Preferred Stock at an
average price of $11.89 (including transaction costs) pursuant to this
repurchase program. In December 1998 the Company completed a previously
authorized repurchase of 1 million shares of common stock at an average price of
$4.10 per share (including transaction costs). In early January 1999, 85,583
formerly restricted shares of common stock were repurchased at $4.12 per share
from employees in order to assist them with meeting their federal income tax
obligations resulting from the lapsing of restrictions on stock awards with the
December 1998 sale of the mortgage banking operations.
Since the first share repurchases in December 1998, the Company has repurchased
6.5 percent of its outstanding shares of common stock and 3.1 percent of its
outstanding shares of the Series B Preferred Stock. As the common stock
continues to sell below its book value per share, share repurchases may
continue. Acquiring common stock at prices below book value per share results in
modest increases in book value per share and net income per share. The Company
ended the quarter with 57,562,000 common shares outstanding. Book values per
common share outstanding at the respective balance sheet dates were as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
<S> <C> <C>
Calculated assuming liquidation of preferred stock* $7.15 $7.88
Calculated assuming redemption of preferred stock** 6.82 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.
Of the 74 cent decline in book value per common share during the nine months
ended September 30, 1999 (calculated assuming redemption of the Company's
convertible preferred stock), $1.05 was attributable primarily to a reduction in
the value of Agency Securities held available-for-sale because of a higher
prevailing intermediate and long-term interest rates. This decline was partially
offset by a 17 cent increase in undistributed income and a 14 cent increase due
to the repurchase of common shares. Note that subsequent to quarter-end, the
Company declared a 16 cent per common share third quarter dividend payable
November 19 to stockholders of record on November 1, 1999.
-18-
<PAGE> 19
RESULTS OF OPERATIONS
Comparative net operating results (interest income or fee revenues, net of
related interest expense and, for CMO administration and the curtailed mortgage
banking operations, related direct and indirect operating expenses) by source
were as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------------- --------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Agency and U.S. Treasury Securities $ 13,515 $ (2,935) $ 40,432 $ 12,147
Non-agency Securities 2,717 1,431 6,858 4,686
CMO collateral and investments (926) (16,704) (2,273) (10,160)
---------- ---------- ---------- ----------
Net margin on mortgage assets and
other investments 15,306 (18,208) 45,017 6,673
Mortgage banking operations -- 13,215 -- 907
Other operating revenue (expense):
Gain (loss) on sale of mortgage assets and
derivative financial instruments -- (991) 1,738 (245,435)
Impairment on CMO investments -- (4,051) -- (4,051)
CMO administration and other 804 1,062 3,177 3,063
Other operating expense (1,588) (2,852) (4,820) (6,044)
---------- ---------- ---------- ----------
Net income (loss) $ 14,522 $ (11,825) $ 45,112 $ (244,887)
========== ========== ========== ==========
Net income (loss) per common share:
Basic $ 0.16 $ (0.28) $ 0.48 $ (4.30)
Diluted 0.16 (0.28) 0.48 (4.30)
</TABLE>
Operating results for the quarter and nine months ended September 30, 1999 were
substantially improved over 1998 results. Liquidity from restructuring the
Company's mortgage asset portfolios and from the December 1998 sale of the
mortgage banking operations has been deployed to reduce short-term borrowings,
which has benefited net margins on the Company's mortgage asset portfolios.
Margins also benefited from first quarter 1999 acquisitions of Agency
Securities, slower prepayments and lower borrowing rates. In 1998 the Company
incurred losses from restructuring its mortgage asset portfolios, and took
impairment charges on mortgage servicing and CMO investments and write-offs of
purchase premiums and CMO bond discounts attributable to high levels of
prepayments and the expectation at that time that such prepayment levels would
continue.
The earning capacity of the Company's mortgage asset portfolios are largely
dependent on the extent to which the Company continues to invest its liquidity
in these portfolios, the overall size and composition of the portfolios and the
relationship between short- and long-term interest rates (the "yield curve").
The Company presently intends to continue to evaluate a number of possibilities
to redeploy some portion of its liquidity into strategic investments in a
variety of real estate-related investments and entities. However, the Company
may conclude to continue to substantially limit its activities to investing in
Agency Securities.
The Company currently expects to maintain its Agency Securities portfolio at
approximately the same level in the fourth quarter of 1999 as in the third
quarter. Although yields on the Company's ARM securities are expected to improve
in future quarters as interest rates on underlying mortgage loans reset to
levels more reflective of the current interest rate environment, fourth quarter
earnings are expected to decline because of higher borrowing costs. If
short-term borrowing rates continue to rise, improving
-19-
<PAGE> 20
mortgage asset yields over the next 12 months would not fully keep pace and net
interest margins would decline. Although Agency Securities have no foreclosure
risk, the Company is subject to reduced interest margins during periods of
rising short-term interest rates or increasing prepayment rates. As a result,
there can be no assurance of increasing or even stable earnings and common
dividends (see "Effects of Interest Rate Changes").
Agency Securities contributed more to operating results during the quarter and
nine months ended September 30, 1999 than Agency and U.S. Treasury Securities
contributed during the same periods in 1998 due primarily to lower borrowings
secured by this portfolio, a larger average outstanding portfolio and improved
financing spreads. On average, the Company employed $439 million of its capital
to this portfolio during both the quarter and nine months ended September 30,
1999 compared to only $50 million and $102 million, respectively, during the
same periods in 1998. The average outstanding portfolio of $5.6 billion during
the current quarter was 29 percent higher than during the same period in 1998.
Yields for this portfolio were 5.85 percent and 5.74 percent during the quarter
and nine months ended September 30, 1999, respectively, compared to 5.32 percent
and 5.79 percent during the same periods in 1998, while average borrowing rates
were 5.19 percent and 5.01 percent, respectively, compared to 5.56 percent
during the same periods in 1998. Yields in 1999 have benefited from lower
prepayments and changes in portfolio mix. In 1998 rapidly declining mortgage
interest rates, particularly late in the third quarter, significantly increased
prepayments and prepayment risk resulting in purchase premium amortization
adjustments, which depressed yields. For further discussion on investment
yields, see "Financial Condition - Mortgage Securities and Other Investments"
and "Effects of Interest Rate Changes."
Non-agency Securities contributed more to operating results during the quarter
and nine months ended September 30, 1999 despite a lower average outstanding
portfolio primarily because the Company funded this portfolio entirely with its
equity. The average outstanding portfolio was $135 million and $116 million
during the quarter and nine months ended September 30, 1999, respectively,
compared to $593 million and $639 million for the same periods in 1998 during
which time only limited capital was employed supporting this portfolio. Average
yields for this portfolio (calculated including mortgage insurance costs) were
8.07 percent and 8.02 percent during the quarter and nine months ended September
30, 1999, respectively, compared to 6.84 percent and 6.80 percent during the
same periods in 1998.
CMO collateral and investments operating results during the quarter and nine
months ended September 30, 1999 were improved over results achieved than during
the same periods in 1998 primarily because of significantly lower prepayments in
1999. In 1998, rapidly declining mortgage interest rates, particularly late in
the third quarter, significantly increased prepayments and prepayment risk
resulting in the third quarter 1998 write-off of $15.7 million of CMO bond
discounts and an impairment charge of $4.1 million to write down to fair value
remaining investments in interest-only securities. The disposition of a $1.0
billion interest-only mortgage securities portfolio in June 1998, subsequent
sales of remaining purchased interest-only mortgage securities and redemptions
of CMOs have significantly diminished the earning capacity of this portfolio.
Without growth of this portfolio either through the issuance of CMOs in which
the Company retains residual interests, or the acquisition of other CMO
investments, it is likely this portfolio will not provide a positive return on
capital employed in future periods.
The mortgage banking operations were sold in December 1998. At December 31, 1998
the Company had established an accrual of over $23 million for contract
settlement provisions and anticipated costs associated with exiting the mortgage
banking operations. During the nine months ended September 30, 1999, the Company
settled approximately $20 million of this liability including a $16 million
prepayment protection settlement payment and over $3 million in pricing
adjustments on mortgage servicing rights acquisition agreements assumed by the
buyer.
-20-
<PAGE> 21
Operating expenses during the quarter and nine months ended September 30, 1999
were higher than in the same periods in 1998 primarily because of a third
quarter of 1998 reclassification of cost allocations between the mortgage
banking operation and other operations of the Company. Ongoing operating
expenses are expected to be at a similar level as incurred during 1999.
The Company did not incur any gains or losses on sales of mortgage assets during
the second or third quarters of 1999. Gains recorded in the first quarter of
1999 relate primarily to the sale of remaining purchased interest-only mortgage
securities held as CMO investments. Losses recorded in 1998 reflect sales of
interest-only mortgage securities and other mortgage assets as part of the
restructuring of the Company's mortgage asset portfolios begun in June 1998 in
response to deteriorating conditions in the mortgage finance industry
experienced at that time.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds include short-term borrowings, monthly
principal and interest payments on mortgage securities and other investments,
excess cash flows on CMO investments and proceeds from sales of mortgage assets.
The Company has substantial liquidity with the 1998 restructuring of its
mortgage asset portfolios and the sale of its mortgage banking operations, which
has been deployed to reduce short-term borrowings (see "Financial Condition").
The Company currently believes that these funds are sufficient for the
acquisition of mortgage assets, repayments on short-term borrowings, the payment
of cash dividends as required for Capstead's continued qualification as a Real
Estate Investment Trust ("REIT") and common and preferred stock repurchases as
described below. In addition, the liquidity provided by the sale of the mortgage
banking operations affords the Company the opportunity to make strategic
investments in a variety of real estate-related investments and entities. There
can be no assurances, however, that the Company will make any such investments.
It is the Company's policy to remain strongly capitalized and conservatively
leveraged.
Short-term borrowings are primarily made under repurchase arrangements. The
Company has uncommitted repurchase facilities with investment banking firms to
finance mortgage assets, subject to certain conditions. Interest rates on
borrowings under these facilities are generally 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 recognition of the potential for greater than normal mortgage finance market
liquidity constraints over year-end 2000, the Company is in the process of
extending its short-term borrowings beyond year-end. As of November 1, 1999, the
Company had financed approximately $2.0 billion of its mortgage investments
under repurchase arrangements with terms extending into the first quarter of
2000.
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 September 30, 1999, 3.1 million and 1.5 million shares
of common and Series B Preferred Stock, respectively, remained available for
repurchase under this program. The Company may continue to repurchase shares in
open market transactions from time to time subject to the price of its
securities and alternative investment opportunities.
-21-
<PAGE> 22
EFFECTS OF INTEREST RATE CHANGES
INTEREST RATE SENSITIVITY ON OPERATING RESULTS
The Company performs earnings sensitivity analysis using an income simulation
model to estimate the effects that specific interest rate changes will have on
future earnings. All mortgage assets and derivative financial instruments
("Derivatives") held, if any, are included in this analysis. In addition, the
sensitivity of CMO administration fee income to market interest rate levels is
included as well. The model incorporates management assumptions regarding the
level of prepayments on mortgage assets for a given level of market rate changes
using industry estimates of prepayment speeds for various coupon segments. These
assumptions are developed through a combination of historical analysis and
future expected pricing behavior. As of September 30, 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* $25,241 $32,489 $7,464 $(35,668)
</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 turn
negative in a rising short-term interest rate environment. Because a substantial
portion of the Company's mortgage investments are ARM mortgage securities, the
risk of rising short-term interest rates is generally offset to some extent by
increases in the rates of interest earned on the underlying ARM loans, which
reset periodically based on underlying indices (generally 6-month LIBOR and
1-year U.S. Treasury rates). Since ARM loans generally limit the amount of such
increases during any single interest rate adjustment period and over the life of
the loan, interest rates on borrowings can rise to levels that may exceed the
interest rates on the underlying loans contributing to lower or even negative
financing spreads. At other times, as seen in 1998, declines in these indices
may be greater than declines in the Company's borrowing rates which are
generally based on 30-day LIBOR, contributing to lower or even negative
financing spreads. The Company may invest in Derivatives from time to time as a
hedge against rising interest rates on a portion of its short-term borrowings.
Currently, the Company does not own any Derivatives as a hedge against rising
interest rates.
-22-
<PAGE> 23
Another effect of changes in interest rates is, as long-term interest rates
decrease, the rate of principal prepayments of mortgage loans underlying
mortgage investments generally increases. To the extent the proceeds of
prepayments on mortgage investments cannot be reinvested at a rate of interest
at least equal to the rate previously earned on such investments, earnings may
be adversely affected. As seen in 1998 prolonged periods of high prepayments can
significantly reduce the expected life of mortgage investments; therefore, the
actual yields realized can be lower due to faster amortization of purchase
premiums. In addition, the rates of interest earned on ARM investments generally
will decline during periods of falling short-term interest rates as the
underlying ARM loans reset at lower rates.
Changes in interest rates also impact earnings recognized from CMO investments,
which have consisted primarily of interest-only mortgage securities and
fixed-rate CMO residuals (see above "Financial Condition"). The amount of income
that may be generated from interest-only mortgage securities is dependent upon
the rate of principal prepayments on the underlying mortgage collateral. If
mortgage interest rates fall significantly below interest rates on the
collateral, principal prepayments may increase, reducing or even turning
negative the overall return on these investments. As seen in 1998 sustained
periods of high prepayments can result in losses. Conversely, if mortgage
interest rates rise, interest-only mortgage securities tend to perform favorably
because underlying mortgage loans will generally prepay at slower rates, thereby
increasing overall returns. The Company sold its investments in 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 turning negative the
overall returns on these investments. This is due primarily to the acceleration
of the amortization of bond discounts, a noncash item, as bond classes are
repaid more rapidly than originally anticipated. Conversely, if mortgage
interest rates rise significantly above interest rates on the collateral,
principal prepayments will typically diminish, improving the overall return on
an investment in a fixed-rate CMO residual because of an increase in time over
which the Company receives the larger positive interest spread.
The Company periodically sells mortgage assets. Such sales may become attractive
as values of mortgage assets fluctuate with changes in interest rates. At other
times, such as in 1998, it may become prudent to significantly downsize mortgage
asset portfolios, for example, to mitigate exposure to further declines in
mortgage interest rates. In either case, sales of mortgage assets may increase
income volatility because of the recognition of transactional gains or losses.
With the sale of the interest-only mortgage securities and the mortgage banking
operations, the Company has significantly reduced its exposure to declining
mortgage interest rates and, therefore, the use of Derivatives to manage this
exposure has been curtailed. As a result, the Company currently does not hold
Derivatives, such as interest rate floors, to help offset the effects of falling
interest rates on the Company's mortgage asset portfolios.
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.
-23-
<PAGE> 24
State of Readiness. The Company has made investments in its software systems and
applications to ensure the Company is Year 2000 compliant. The Company has also
taken steps to ensure that the vendors it utilizes and institutions that it
interfaces with have also taken the necessary steps to become Year 2000
compliant. This process was completed in the third quarter of 1999. In addition,
with the sale of the mortgage banking operations in December 1998, the Company
has built a new computer network that is considered to be Year 2000 compliant.
Costs. The financial costs of becoming Year 2000 compliant for the ongoing
operations of the Company, including the construction of the Company's new
computer network, have not exceeded $600,000.
Risks and Contingency Planning. The Company considers all its systems and
applications to be Year 2000 compliant, and has taken steps to ensure that all
of the vendors it utilizes and institutions that it interfaces with have
completed their compliance efforts. Nonetheless, the Company will continue to
monitor Year 2000 compliance and has drafted 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 because of
changes in the level and composition of the Company's investments and unforeseen
factors. These factors may include, but are not limited to, changes in general
economic conditions, the availability of suitable investments, fluctuations in
and market expectations for fluctuations in interest rates and levels of
mortgage prepayments, the effectiveness of risk management strategies, the
impact of leverage, liquidity of credit markets, Year 2000 compliance failures,
increases in costs and other general competitive factors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS
The information required by this Item is incorporated by reference to the
information included in Item 2. "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) Exhibits: The following Exhibits are presented herewith:
Exhibit 11 -- Computation of Earnings Per Share for the Quarter and Nine
Months Ended September 30, 1999 and 1998.
Exhibit 12 -- Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends.
Exhibit 27 -- Financial Data Schedule (electronic filing only).
(b) Reports on Form 8-K: None.
-24-
<PAGE> 25
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: November 10, 1999 By: /s/ RONN K. LYTLE
------------------------------------
Ronn K. Lytle
Chairman and Chief Executive Officer
Date: November 10, 1999 By: /s/ ANDREW F. JACOBS
-----------------------------------
Andrew F. Jacobs
Executive Vice President - Finance
-25-
<PAGE> 26
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
11 Computation of Earnings Per Share for the Quarter and Nine
Months Ended September 30, 1999 and 1998.
12 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
COMPUTATION OF NET INCOME PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------------- --------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
BASIC AND DILUTED*:
Average number of common
shares outstanding 57,861 61,575 58,787 60,786
Net income (loss) $ 14,522 $ (11,825) $ 45,112 $ (244,887)
Less cash dividends paid on
convertible preferred stock:
Series A ($0.40 per share) (150) (150) (449) (460)
Series B ($0.315 per share) (5,301) (5,449) (16,117) (16,284)
Repurchase price in excess of recorded value (92) -- (386)
---------- ---------- ---------- ----------
Net income (loss) available to
common stockholders $ 8,979 $ (17,424) $ 28,160 $ (261,631)
========== ========== ========== ==========
Basic and diluted net income (loss)
per common share $ 0.16 $ (0.28) $ 0.48 $ (4.30)
</TABLE>
* The Series A and B Preferred Stocks were not considered convertible for
purposes of calculating diluted net income (loss) per common share for the
periods presented because the effects of conversion were antidilutive
<PAGE> 1
EXHIBIT 12
CAPSTEAD MORTGAGE CORPORATION
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>
NINE MONTHS YEAR ENDED DECEMBER 31
ENDED -----------------------------------------------------------------------
SEPTEMBER 30, 1999 1998 1997 1996 1995 1994
------------------ ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Fixed charges $ 371,728 $ 673,233 $ 633,845 $ 598,312 $ 584,137 $ 474,844
Preferred stock dividends 16,952 22,342 25,457 36,356 39,334 38,876
---------- ---------- ---------- ---------- ---------- ----------
Combined fixed charges and
preferred stock dividends 388,680 695,575 659,302 634,668 623,471 513,720
Net income (loss) 45,112 (234,764) 159,926 127,228 77,359 85,579
---------- ---------- ---------- ---------- ---------- ----------
Total $ 433,792 $ 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>
NINE MONTHS YEAR ENDED DECEMBER 31
ENDED -----------------------------------------------------------------------
SEPTEMBER 30, 1999 1998 1997 1996 1995 1994
------------------ ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Fixed charges $ 161,987 $ 332,985 $ 352,348 $ 283,974 $ 223,751 $ 139,188
Preferred stock dividends 16,952 22,342 25,457 36,356 39,334 38,876
---------- ---------- ---------- ---------- ---------- ----------
Combined fixed charges and
preferred stock dividends 178,939 355,327 377,805 320,330 263,085 178,064
Net income (loss) 45,112 (234,764) 159,926 127,228 77,359 85,579
---------- ---------- ---------- ---------- ---------- ----------
Total $ 224,051 $ 120,563 $ 537,731 $ 447,558 $ 340,444 $ 263,643
========== ========== ========== ========== ========== ==========
Ratio of earnings to combined
fixed charges and preferred
stock dividends 1.25:1 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 SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 12,718
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 9,137,621
<CURRENT-LIABILITIES> 5,117,132
<BONDS> 3,412,512
0
192,409
<COMMON> 576
<OTHER-SE> 414,992
<TOTAL-LIABILITY-AND-EQUITY> 9,137,612
<SALES> 0
<TOTAL-REVENUES> 423,265
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 6,425
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 371,728
<INCOME-PRETAX> 45,112
<INCOME-TAX> 0
<INCOME-CONTINUING> 45,112
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 45,112
<EPS-BASIC> 0.48
<EPS-DILUTED> 0.48
</TABLE>
