<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: SEPTEMBER 30, 2000
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.)
8401 NORTH CENTRAL EXPRESSWAY, SUITE 800, DALLAS, TX 75225
(Address of principal executive offices) (Zip Code)
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) 22,593,472 as of November 9, 2000
<PAGE> 2
CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2000
INDEX
PART I. - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ITEM 1. Financial Statements
Consolidated Balance Sheets - September 30, 2000 and December 31, 1999................................ 3
Consolidated Statements of Operations - Quarter and Nine Months Ended
September 30, 2000 and 1999.......................................................................... 4
Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 2000 and 1999.......................................................................... 5
Notes to Consolidated Financial Statements............................................................. 6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations........................................... 15
ITEM 3. Qualitative and Quantitative Disclosure of Market Risk.................................... 24
PART II. - OTHER INFORMATION
ITEM 1. Legal Proceedings......................................................................... 25
ITEM 6. Exhibits and Reports on Form 8-K.......................................................... 25
SIGNATURES................................................................................................ 26
</TABLE>
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<PAGE> 3
PART I. -- FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
------------------ -----------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Mortgage securities and other investments $ 5,227,152 $ 5,408,714
CMO collateral and investments 3,224,728 3,318,886
----------- -----------
8,451,880 8,727,600
Prepaids, receivables and other 63,356 48,451
Restricted cash and cash equivalents -- 2,500
Cash and cash equivalents 25,323 28,488
----------- -----------
$ 8,540,559 $ 8,807,039
=========== ===========
LIABILITIES
Borrowings under repurchase arrangements $ 4,763,276 $ 4,872,392
Collateralized mortgage obligations ("CMO") borrowings 3,200,624 3,289,584
Accounts payable and accrued expenses 22,560 30,673
----------- -----------
7,986,460 8,192,649
----------- -----------
PREFERRED STOCK SUBJECT TO REPURCHASE
$0.10 par value; 10,756 shares authorized, issued and
outstanding ($52,735 aggregate repurchase amount) 50,420 50,584
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value; 89,244 shares authorized:
$1.60 Cumulative Preferred Stock, Series A,
374 shares issued and outstanding at September 30,
2000 and December 31, 1999 ($6,134 aggregate
liquidation preference) 5,228 5,228
$1.26 Cumulative Convertible Preferred Stock, Series B,
15,845 and 16,673 shares issued and outstanding at
September 30, 2000 and December 31, 1999, respectively
($180,316 aggregate liquidation preference) 177,012 186,248
Common stock - $0.01 par value; 100,000 shares authorized;
22,589 and 28,428 shares issued and outstanding at
September 30, 2000 and December 31, 1999, respectively 226 284
Paid-in capital 715,354 769,902
Accumulated deficit (394,297) (304,568)
Accumulated other comprehensive income (loss) 156 (93,288)
----------- -----------
503,679 563,806
----------- -----------
$ 8,540,559 $ 8,807,039
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE> 4
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------- -------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Mortgage securities and other investments $ 86,229 $ 84,092 $ 256,187 $ 209,554
CMO collateral and investments 59,751 63,725 179,418 208,796
--------- --------- --------- ---------
Total interest income 145,980 147,817 435,605 418,350
--------- --------- --------- ---------
INTEREST AND RELATED EXPENSE:
Borrowings under repurchase arrangements 76,058 67,746 222,266 161,987
CMO borrowings 59,879 64,309 179,836 209,741
Mortgage insurance and other 380 456 1,199 1,605
--------- --------- --------- ---------
Total interest and related expense 136,317 132,511 403,301 373,333
--------- --------- --------- ---------
Net margin on mortgage assets and
other investments 9,663 15,306 32,304 45,017
--------- --------- --------- ---------
OTHER REVENUE (EXPENSE):
Loss on portfolio restructuring -- -- (90,008) --
Severance costs -- -- (3,607) --
Gain on sale of mortgage securities 747 -- 747 1,738
CMO administration and other 781 804 2,458 3,177
Other operating expense (1,424) (1,588) (4,709) (4,820)
--------- --------- --------- ---------
Total other revenue (expense) 104 (784) (95,119) 95
--------- --------- --------- ---------
NET INCOME (LOSS) $ 9,767 $ 14,522 $ (62,815) $ 45,112
========= ========= ========= =========
Net income (loss) $ 9,767 $ 14,522 $ (62,815) $ 45,112
Less cash dividends on preferred shares (6,372) (5,543) (18,367) (16,952)
--------- --------- --------- ---------
Net income (loss) available to common stockholders $ 3,395 $ 8,979 $ (81,182) $ 28,160
========= ========= ========= =========
BASIC AND DILUTED NET INCOME (LOSS) PER COMMON SHARE $ 0.15 $ 0.31 $ (3.50) $ 0.96
CASH DIVIDENDS DECLARED PER SHARE:
Common $ 0.120 $ 0.320 $ 0.500 $ 0.960
Series A preferred 0.400 0.400 1.200 1.200
Series B preferred 0.315 0.315 0.945 0.945
Series C preferred 0.140 -- 0.420 --
Series D preferred 0.100 -- 0.300 --
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE> 5
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
-----------------------------
2000 1999
----------- -----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ (62,815) $ 45,112
Noncash items:
Amortization of discount and premium 12,960 34,397
Depreciation and other amortization 741 797
Impairment of mortgage securities designated for sale in
connection with portfolio restructuring 19,088 --
Loss on sale of mortgage securities in connection with
portfolio restructuring 70,920 --
Gain on sale of mortgage securities (747) (1,738)
Net change in prepaids, receivables, other assets, accounts
payable and accrued expenses (9,707) (13,181)
----------- -----------
Net cash provided by operating activities 30,440 65,387
----------- -----------
INVESTING ACTIVITIES:
Purchases of mortgage securities and other investments (1,913,604) (4,317,389)
Purchases of CMO collateral (235,999) --
Principal collections on mortgage investments 681,173 1,010,216
Proceeds from sales of mortgage assets 1,404,321 114,763
Proceeds from sale and settlement of derivative financial instruments -- 12,595
CMO collateral:
Principal collections 326,283 955,346
Decrease in accrued interest receivable 2,107 7,151
Decrease in short-term investments 178 13,664
----------- -----------
Net cash provided by (used in) investing activities 264,459 (2,203,654)
----------- -----------
FINANCING ACTIVITIES:
Increase (decrease) in short-term borrowings (109,116) 3,257,397
CMO borrowings:
Issuance of securities 235,999 --
Principal payments on securities (332,174) (1,115,998)
Decrease in accrued interest payable (1,783) (6,915)
Capital stock transactions (64,076) (21,295)
Dividends paid (26,914) (35,589)
----------- -----------
Net cash provided by (used in) financing activities (298,064) 2,077,600
----------- -----------
Net change in cash and cash equivalents (3,165) (60,667)
Cash and cash equivalents at beginning of period 28,488 73,385
----------- -----------
Cash and cash equivalents at end of period $ 25,323 $ 12,718
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE> 6
CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(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. After having modified its investment strategy in April 2000 to focus
on adjustable-rate and short-maturity assets, the Company's current mortgage
investment portfolio consists primarily of adjustable-rate, single-family
residential mortgage-backed securities issued by Fannie Mae, Freddie Mac and
Ginnie Mae ("Agency Securities"). Fannie Mae, Freddie Mac and Ginnie Mae are
also referred to as FNMA, FHLMC and GNMA, respectively.
NOTE 2 - BASIS OF PRESENTATION
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 periods ended
September 30, 2000 are not necessarily indicative of the results that may be
expected for the calendar year ending December 31, 2000. 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, 1999.
1-For-2 Reverse Common Stock Split. At the Company's Annual Meeting of
Stockholders held April 20, 2000, stockholders approved a 1-for-2 reverse common
stock split. Accordingly, the Board of Directors established the close of
business on May 8, 2000 as the effective date for the reverse split. The first
day the common shares traded post-split was May 9, 2000. The reverse split
reduced the number of outstanding common shares to approximately 22.6 million.
All share and per share information presented has been restated to reflect the
reverse common stock split.
NOTE 3 - SHARE REPURCHASES AND DECLARATION OF COMMON STOCK DIVIDEND
During the nine months ended September 30, 2000, the Company acquired, through
open market purchases, 376,950 common shares at an average price of $7.77
(including transaction costs) and 826,900 shares of its Series B preferred
shares at an average price of $9.61 (including transaction costs). On January
25, 2000 the Company purchased 5,568,500 common shares at a price of $9.27 per
share (including transaction costs) pursuant to a tender offer that closed on
January 14, 2000. Since share repurchases began in December 1998 through
September 30, 2000, the Company has repurchased 26.9% of its outstanding common
shares and 8.4% of its Series B preferred shares. As of September 30, 2000, the
Company had remaining authorization to repurchase 819,300 common shares and
551,100 Series B preferred shares.
On October 19, 2000 the Board of Directors declared a third quarter dividend of
$0.12 per common share, payable November 20 to stockholders of record as of
November 1, 2000.
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<PAGE> 7
NOTE 4 - NET INCOME (LOSS) PER COMMON SHARE
Basic net income (loss) per common share is computed by dividing net income
(loss) after deducting preferred share dividends* by the weighted average number
of common shares outstanding. Diluted net income (loss) per common share is
computed by dividing net income (loss), after deducting preferred share
dividends for antidilutive convertible preferred shares, by the weighted average
number of common shares, dilutive stock options and dilutive convertible
preferred shares outstanding. The components of the computation of basic and
diluted net income (loss) per share for the periods indicated are as follows (in
thousands, except per share data):
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
---------------------- -----------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Numerator for basic net income (loss) per common share:
Net income (loss) $ 9,767 $ 14,522 $(62,815) $ 45,112
Less all preferred share dividends* (6,372) (5,543) (18,367) (16,952)
-------- -------- -------- --------
Net income (loss) available to common
stockholders $ 3,395 $ 8,979 $(81,182) $ 28,160
======== ======== ======== ========
Weighted average common shares outstanding 22,589 28,931 23,162 29,394
Basic net income (loss) per common share $ 0.15 $ 0.31 $ (3.50) $ 0.96
Numerator for diluted net income (loss) per
common share:
Net income (loss) $ 9,767 $ 14,522 $(62,815) $ 45,112
Less cash dividends paid on antidilutive
convertible preferred shares:
Series A (150) (150) (449) (449)
Series B (5,017) (5,301) (15,332) (16,117)
Series B repurchase amounts less than
(in excess of) book value* 86 (92) 1,286 (386)
Series C (753) ** (2,259) **
Series D (538) ** (1,613) **
-------- -------- -------- --------
$ 3,395 $ 8,979 $(81,182) $ 28,160
======== ======== ======== ========
Denominator for diluted net income (loss) per common share:
Weighted average common shares outstanding 22,589 28,931 23,162 29,394
Net effect of dilutive stock options 76 10 -- 10
Net effect of dilutive preferred shares -- -- -- --
-------- -------- -------- --------
22,665 28,941 23,162 29,404
======== ======== ======== ========
Diluted net income (loss) per common share $ 0.15 $ 0.31 $ (3.50) $ 0.96
</TABLE>
* Included as a component of the Series B preferred share dividends in the
calculation of both basic and diluted net income (loss) per common share,
is the difference between repurchase amounts and the Series B preferred
shares book value of $11.17 per share.
** Not applicable.
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<PAGE> 8
NOTE 5 - MORTGAGE SECURITIES AND OTHER INVESTMENTS
Mortgage 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 PREMIUMS CARRYING AVERAGE EFFECTIVE
BALANCE (DISCOUNTS) BASIS AMOUNT COUPON RATE
----------- ----------- ------------ ------------ ---------- ---------
SEPTEMBER 30, 2000 * ** **
<S> <C> <C> <C> <C> <C> <C>
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 3,630 $ 17 $ 3,647 $ 3,872 10.00% 9.79%
Medium-term*** 627,909 (6,620) 621,289 620,655 6.18 6.99
ARMs:
LIBOR/CMT 1,865,639 35,741 1,901,380 1,905,323 7.99 6.90
COFI*** 217,516 (5,354) 212,162 214,458 6.52 7.42
GNMA ARMs 2,292,424 18,502 2,310,926 2,302,383 6.76 6.64
---------- ----------- ---------- ---------- ----- -----
5,007,118 42,286 5,049,404 5,046,691 7.13 6.81
Non-agency securities 102,474 -- 102,474 104,449 8.22 8.00
CMBS - adjustable-rate 75,911 (788) 75,123 76,012 8.60 9.41
---------- ----------- ---------- ---------- ----- -----
$5,185,503 $ 41,498 $5,227,001 $5,227,152 7.18% 6.89%
========== =========== ========== ========== ===== =====
DECEMBER 31, 1999
Agency Securities:
FNMA/FHLMC:
Fixed-rate $1,063,822 $ (2,924) $1,060,898 $1,009,577 6.18% 6.23%
Medium-term 1,123,984 4,516 1,128,500 1,103,704 6.15 5.89
ARMs:
LIBOR/CMT 911,262 20,824 932,086 935,291 7.03 5.63
COFI 242,573 1,570 244,143 237,721 5.84 5.62
GNMA ARMs 1,924,659 26,083 1,950,742 1,936,032 6.29 5.65
---------- ----------- ---------- ---------- ----- -----
5,266,300 50,069 5,316,369 5,222,325 6.35 5.81
Non-agency securities 126,431 385 126,816 127,059 8.34 8.06
CMBS - adjustable-rate 60,182 (852) 59,330 59,330 7.54 8.53
---------- ----------- ---------- ---------- ----- -----
$5,452,913 $ 49,602 $5,502,515 $5,408,714 6.41% 5.87%
========== =========== ========== ========== ===== =====
</TABLE>
* Includes mark-to-market for securities classified as
available-for-sale, if applicable (see NOTE 9).
** Average Coupon is calculated as of the indicated balance sheet date.
Average Effective Rate is calculated for the quarter then ended.
*** The COFI ARM securities and $440.3 million of the medium-term Agency
Securities have been designated for sale in connection with the April
2000 portfolio restructuring (see NOTE 1).
The Company classifies its Agency Securities and non-agency securities by
interest rate characteristics of the underlying single-family residential
mortgage loans. Commercial mortgage-backed securities ("CMBS") are classified in
a similar fashion. 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 the 1-year Constant Maturity U.S. Treasury Note Rate ("1-year CMT"), 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 CMT, (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
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<PAGE> 9
at the time of adjustment, or (iii) are fixed-rate mortgage securities that have
expected weighted average lives of 5 years or less. Adjustable-rate mortgage
("ARM") 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 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"), (iv) were previously classified as
medium-term and have begun adjusting annually based on a specified margin over
1-year CMT, or (v) in the case of CMBS held as of September 30, 2000, adjust
monthly based on a specified margin over 30-day LIBOR.
Agency Securities are AAA-rated and 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"). Although currently investment grade, CMBS held by the Company at
September 30, 2000 carry credit risk associated with the underlying commercial
mortgage loans. Features of the related CMBS issuance, including subordinated
securities held by other investors, help mitigate this risk. The maturity of
mortgage-backed securities is directly affected by the rate of principal
prepayments on the underlying loans.
NOTE 6 - CMO COLLATERAL AND INVESTMENTS
CMO collateral consists of fixed-rate, medium-term and adjustable-rate mortgage
securities collateralized by single-family residential mortgage loans and
related short-term investments, both pledged to secure CMO borrowings ("Pledged
CMO Collateral"). All principal and interest on pledged mortgage securities is
remitted directly to collection accounts 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 $860,000 of
credit risk in the form of subordinated bonds associated with approximately $520
million of Pledged CMO Collateral outstanding as of September 30, 2000. The
weighted average effective interest rate for total Pledged CMO Collateral was
7.33% during the quarter ended September 30, 2000.
CMO investments currently consist of reserve funds retained by the Company in
connection with two 1993 mortgage loan sales. These reserve funds are available
to pay special hazard (e.g. earthquake or mudslide-related losses) or certain
bankruptcy costs associated with approximately $131 million of loans outstanding
as of September 30, 2000 from the related securitizations. The components of CMO
collateral and investments are summarized as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
------------------ -----------------
<S> <C> <C>
Pledged CMO Collateral:
Pledged mortgage securities $3,185,802 $3,283,848
Short-term investments 582 760
Accrued interest receivable 19,271 19,461
---------- ----------
3,205,655 3,304,069
Unamortized premium 16,288 11,633
---------- ----------
3,221,943 3,315,702
CMO investments 2,785 3,184
---------- ----------
$3,224,728 $3,318,886
========== ==========
</TABLE>
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<PAGE> 10
NOTE 7 - BORROWINGS UNDER REPURCHASE ARRANGEMENTS
Borrowings made under uncommitted repurchase arrangements with investment
banking firms pursuant to which the Company pledges mortgage securities as
collateral generally have maturities of less than 31 days. Repurchase
arrangements with CMBS pledged as collateral generally have maturities similar
to the expected maturities of the related collateral. The terms and conditions
of these arrangements are negotiated on a transaction-by-transaction basis.
Repurchase arrangements and related average effective interest rates are
classified by type of collateral and maturities as follows as of the indicated
balance sheet date (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
--------------------------- --------------------------
WEIGHTED WEIGHTED
BORROWINGS AVERAGE BORROWINGS AVERAGE
OUTSTANDING RATE OUTSTANDING RATE
------------ ----------- ------------- ----------
<S> <C> <C> <C> <C>
Agency Securities (less than 31 days) $4,692,986 6.57% $2,405,436 5.81%
Agency Securities (31 to 90 days) - - 2,012,810 6.38
Agency Securities (over 90 days) - - 280,347 6.41
Non-agency Securities (less than 31 days) 7,416 6.85 - -
Non-agency Securities (over 90 days) - - 124,361 6.62
CMBS (over 1 year) 62,874 7.15 49,438 7.01
---------- ---- ---------- ----
$4,763,276 6.57% $4,872,392 6.11%
========== ==== ========== ====
</TABLE>
The weighted average effective interest rate on borrowings under repurchase
arrangements was 6.57% during the quarter ended September 30, 2000. As of
September 30, 2000, $4.9 billion of mortgage securities were pledged as
collateral under repurchase arrangements.
NOTE 8 - CMO BORROWINGS
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 CMO
borrowings along with selected other information are summarized as follows
(dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
------------------ -----------------
<S> <C> <C>
CMOs $3,184,298 $3,281,464
Accrued interest payable 18,230 18,096
---------- ----------
Total obligation 3,202,528 3,299,560
Unamortized discount (1,904) (9,976)
---------- ----------
$3,200,624 $3,289,584
========== ==========
Range of average interest rates 4.99% to 9.45% 5.13% to 9.45%
Range of stated maturities 2008 to 2028 2008 to 2028
Number of series 25 24
</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 7.39% during the quarter ended September 30, 1999.
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<PAGE> 11
NOTE 9 - 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, CMBS 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. 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 SEPTEMBER 30, 2000
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 3,647 $ 225 $ -- $ 3,872
Medium-term 621,289 2,198 2,832 620,655
ARMs:
LIBOR/CMT 1,901,380 5,868 1,925 1,905,323
COFI 212,162 2,296 -- 214,458
GNMA ARMs 2,310,926 3,330 11,873 2,302,383
Non-agency securities 102,474 1,975 -- 104,449
CMBS - adjustable-rate 75,123 891 2 76,012
CMO collateral and investments 80,813 218 213 80,818
---------- ------- ---------- ----------
$5,307,814 $17,001 $ 16,845 $5,307,970
========== ======= ========== ==========
AS OF DECEMBER 31, 1999
Agency Securities:
Fixed-rate $1,060,898 $ 268 $ 51,589 $1,009,577
Medium-term 1,128,500 39 24,835 1,103,704
ARMs 3,126,971 4,659 22,586 3,109,044
Non-agency Securities 28,817 249 6 29,060
CMBS - adjustable-rate 59,330 -- -- 59,330
CMO collateral and investments 103,142 697 184 103,655
---------- ------- ---------- ----------
$5,507,658 $ 5,912 $ 99,200 $5,414,370
========== ======= ========== ==========
</TABLE>
-11-
<PAGE> 12
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 GAINS LOSSES VALUE
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
AS OF SEPTEMBER 30, 2000
Pledged CMO Collateral $3,143,910 $ 1,272 $ 15,064 $3,130,118
========== ======= ========== ==========
AS OF DECEMBER 31, 1999
Non-agency securities $ 97,999 $ 1,277 $ -- $ 99,276
Pledged CMO Collateral 3,215,231 1,620 18,183 3,198,668
---------- ------- ---------- ----------
$3,313,230 $ 2,897 $ 18,183 $3,297,944
========== ======= ========== ==========
</TABLE>
Sales of released CMO collateral occasionally occur provided the collateral has
paid down to within 15% 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
------------------------ --------------------------
2000 1999 2000 1999
-------- ------- ----------- ------
<S> <C> <C> <C> <C>
Sale of securities held available-for-sale:
Amortized cost $ 15,010 $ -- $ 1,389,568 $7,753
Gains (losses) (69) -- (70,989) 1,761
Sale of released CMO collateral held-to-maturity:
Amortized cost 84,547 -- 84,547 --
Gains 816 -- 816 --
</TABLE>
NOTE 10 - 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
------------------------- -------------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income (loss) $ 9,767 $ 14,522 $(62,815) $ 45,112
-------- -------- -------- --------
Other comprehensive income (loss):
Unrealized gain (loss) on debt securities:
Change in unrealized gain (loss) during period 23,712 (23,141) 3,367 (58,691)
Reclassification adjustment for (gain) loss
included in net income (loss) 69 -- 90,077 (1,761)
-------- -------- -------- --------
Other comprehensive income (loss) 23,781 (23,141) 93,444 (60,452)
-------- -------- -------- --------
$ 33,548 $ (8,619) $ 30,629 $(15,340)
======== ======== ======== ========
</TABLE>
-12-
<PAGE> 13
NOTE 11 - 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
---------------------------------------------------------
2000 1999
-------------------------- ------------------------
AMOUNT AVERAGE AMOUNT AVERAGE
---------- --------- --------- ---------
<S> <C> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ 86,229 6.89% $ 84,092 5.90%
CMO collateral and investments 59,751 7.32 63,725 7.22
---------- ----------
Total interest income 145,980 147,817
---------- ----------
Interest expense:
Short-term borrowings 76,058 6.57 67,746 5.19
CMO borrowings 59,879 7.39 64,309 7.34
---------- ----------
Total interest expense 135,937 132,055
---------- ----------
$ 10,043 $ 15,762
========== ==========
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30
------------------------------------------------------
2000 1999
------------------------ ------------------------
AMOUNT AVERAGE AMOUNT AVERAGE
---------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ 256,187 6.54% $ 209,554 5.80%
CMO collateral and investments 179,418 7.27 208,796 7.16
--------- ---------
Total interest income 435,605 418,350
--------- ---------
Interest expense:
Short-term borrowings 222,266 6.22 161,987 5.01
CMO borrowings 179,836 7.34 209,741 7.25
--------- ---------
Total interest expense 402,102 371,728
--------- ---------
$ 33,503 $ 46,622
========= =========
</TABLE>
The following tables summarize increases (decreases) 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, 2000
------------------------------------------
RATE* VOLUME* TOTAL
-------- --------- ---------
<S> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ 13,042 $(10,905) $ 2,137
CMO collateral and investments 907 (4,881) (3,974)
-------- -------- -------
Total interest income 13,949 (15,786) (1,837)
-------- -------- -------
Interest expense:
Short-term borrowings 16,740 (8,428) 8,312
CMO borrowings 444 (4,874) (4,430)
-------- -------- -------
Total interest expense 17,184 (13,302) 3,882
-------- -------- -------
$ (3,235) $ (2,484) $(5,719)
======== ======== =======
</TABLE>
-13-
<PAGE> 14
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 2000
-----------------------------------------
RATE* VOLUME* TOTAL
--------- ---------- ---------
<S> <C> <C> <C>
Interest income:
Mortgage securities and other investments $ 27,719 $ 18,914 $ 46,633
CMO collateral and investments 3,020 (32,398) (29,378)
-------- -------- --------
Total interest income 30,739 (13,484) 17,255
-------- -------- --------
Interest expense:
Short-term borrowings 41,971 18,308 60,279
CMO borrowings 2,488 (32,393) (29,905)
-------- -------- --------
Total interest expense 44,459 (14,085) 30,374
-------- -------- --------
$(13,720) $ 601 $(13,119)
======== ======== ========
</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 12 - COMMITMENTS AND CONTINGENCIES
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 and in July 2000 a lead plaintiff group was appointed by the
court. An amended complaint was filed October 20, 2000. The Company expects to
respond to this amended complaint no later than mid-February 2001. The Company
believes it has meritorious defenses to the claims and intends to vigorously
defend the actions. Based on available information, management believes the
resolution of these suits will not have a material adverse effect on the
financial position of the Company.
NOTE 13 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes new accounting and
reporting standards for derivative financial instruments ("Derivatives") and
hedging activities. It requires an entity to recognize all Derivatives as either
assets or liabilities in the statement of financial position and to measure
those instruments at fair value. If certain conditions are met, a Derivative may
be specifically designated as (i) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment,
(ii) a hedge of the exposure to variable cash flows of a forecasted transaction,
or (iii) in certain circumstances, a hedge of a foreign currency exposure. This
statement is effective for the Company's fiscal year ending December 31, 2001.
Adopting SFAS 133 on January 1, 2001 is expected to have a less than $2 million
positive impact on the Company's financial position due to recognizing certain
clean-up call rights on off-balance sheet securitizations as cash flow hedge
instruments in other comprehensive income. Adopting SFAS 133 is not expected to
have any impact on the Company's results of operations.
-14-
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
Capstead Mortgage Corporation ("Capstead" or the "Company"), a mortgage
investment firm, earns income from investing in mortgage assets on a leveraged
basis and from other investment strategies.
ELECTION OF NEW LEADERSHIP
At the Company's Annual Meeting of Stockholders held April 20, 2000,
stockholders elected a new Board of Directors including Wesley R. Edens,
chairman of the board of Fortress Investment Group LLC ("Fortress"). An
affiliate of Fortress acquired the Company's Series C and D preferred shares in
December 1999 and on July 1, 2000 completed a tender offer acquiring 2.9 million
common shares. As of October 23, 2000, the affiliate has reported acquiring
912,000 additional common shares. Together, these investments represent 33% of
the voting shares of Capstead. The composition of the new Board of Directors
includes four members designated by Fortress and three members designated by
Capstead, two of whom are continuing directors from the previous Board. In
addition, the Board announced the appointment of (i) Mr. Edens to the positions
of Chairman of the Board and Chief Executive Officer of the Company, and (ii)
Ronn K. Lytle, the Company's previous chairman and chief executive, to the
position of Vice Chairman of the Board.
ADOPTION OF NEW INVESTMENT STRATEGY
During 1999 the Company's primary focus consisted of 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 included fixed-rate and medium-term Agency
Securities as well as adjustable-rate mortgage ("ARM") securities (see "NOTE 5"
to the accompanying consolidated financial statements for further discussion of
how the Company classifies its mortgage securities and other investments). On
April 20, 2000 the Board approved modifying the Company's investment strategy to
focus on adjustable-rate and short maturity assets, including, but not limited
to, ARM Agency Securities and credit-sensitive commercial and residential
mortgage-backed securities. By focusing the Company's investments on assets that
adjust to a more current interest rate within one to twelve months, Capstead's
new investment strategy is intended to help preserve capital and improve
earnings prospects over the long term.
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 are AAA-rated and have no foreclosure risk;
however, Capstead 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"). 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"). Although currently
investment grade, commercial mortgage-backed securities ("CMBS") held by the
Company carry credit risk associated with the underlying commercial mortgage
loans. Features of the related CMBS issuances, including subordinated securities
held by other investors, helps mitigate this risk (see "Risks Associated With
Credit-Sensitive Investments"). Mortgage securities and other investments are
financed under repurchase arrangements with investment banking firms pursuant to
which the portfolios are pledged as collateral
-15-
<PAGE> 16
(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 securities portfolio and its currently projected
fourth quarter 2000 earnings capacity:
<TABLE>
<CAPTION>
3RD QUARTER AVERAGE AS OF SEPTEMBER 30, 2000
----------------------------------- ------------------------- PROJECTED LIFETIME
ACTUAL ACTUAL PREMIUMS 4TH QUARTER PREPAYMENT
BASIS YIELD/COST RUNOFF (DISCOUNTS) BASIS YIELD/COST ASSUMPTIONS
----- ---------- ------ ----------- ----- ---------- -----------
* * **
<S> <C> <C> <C> <C> <C> <C> <C>
Agency Securities:
FNMA/FHLMC:
Fixed-rate $ 3,727 9.79% 16% $ 17 $ 3,647 9.66% 25%
Medium-term 651,791 6.99 20 (6,620) 621,289 6.99 18
ARMs:
LIBOR/CMT 1,518,401 6.90 22 35,741 1,901,380 7.17 40
COFI 217,190 7.42 14 (5,354) 212,162 7.67 15
GNMA ARMs 2,370,779 6.64 17 18,502 2,310,926 6.99 24
------------ ---- -- -------- ------------ ---- --
4,761,888 6.81 19 42,286 5,049,404 7.09 29
Non-agency Securities 163,670 8.00 18 - 102,474 8.26 30
CMBS - adjustable-rate 75,075 9.41 - (788) 75,123 9.21 -
----------- ---- -- ------- ------------ ---- --
5,000,633 6.89 19% $41,498 5,227,001 7.14 28%
== ======= ==
Borrowings *** (4,529,094) (6.57) (4,763,276) (6.63)
------------ ---- ------------ ----
Capital employed/
financing spread $ 471,539 0.32% $ 463,725 0.51%
============ ==== ============ ====
Return on assets **** 0.80% 0.95%
==== ====
</TABLE>
* Basis represents the Company's investment before mark-to-market.
** Projected yields reflect 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 (i) changes in portfolio composition, (ii) ARM security
coupon resets, (iii) actual prepayments and (iv) any changes in
lifetime prepayment assumptions.
*** Borrowing rates 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 borrowings. Return on assets
is calculated assuming the use of this liquidity to reduce borrowing
costs.
In connection with modifying its investment strategy, during the second quarter
the Company sold $1.4 billion of fixed-rate and medium-term mortgage investments
and designated for sale nearly $700 million of primarily medium-term securities,
incurring a charge to operating results of $90.0 million. The charge consisted
of realized losses of $70.9 million and a $19.1 million reduction in the
Company's basis in securities designated for sale. During the third quarter,
$100 million of fixed-rate Non-agency Securities were sold, reducing holdings of
fixed-rate securities in the mortgage securities portfolio to less than $5
million. With the capital made available from these sales, the Company acquired
$1.1 billion of ARM Agency Securities during the second quarter, an additional
$706 million in the third quarter, and will continue to redeploy its capital in
keeping with the new investment strategy, subject to the availability of
suitable investments.
Consistent with the Company's new investment strategy, in December 1999 Capstead
acquired $59 million of adjustable-rate CMBS. Because of recent market
conditions, the pricing for these securities has been less attractive on a
risk-adjusted return basis than other suitable investments. Consequently, only
$17 million has been added to the CMBS portfolio since year-end, all during the
first quarter. In addition, during 2000 the Company acquired $105 million of ARM
Non-agency Securities
-16-
<PAGE> 17
through the redemption of 4 series of off-balance sheet collateralized mortgage
obligations ("CMOs") previously issued by the Company. Runoff on mortgage
securities investments totaled approximately $681 million during the nine months
ended September 30, 2000.
The unamortized net premium paid for these portfolios (referred to as "premiums
(discounts)") was $41.5 million at September 30, 2000, representing 0.80% of
related unpaid principal balances. Prepayments remained relatively low during
the third quarter because of continued high mortgage interest rates. Lower
prepayment levels improve mortgage investment yields by allowing related
purchase premiums to be recognized in operating results over a longer period.
Annualized prepayments on Fannie Mae and Freddie Mac ARM securities averaged
22.4% for the third quarter, slightly higher than the 21.9% annualized rate for
the second quarter but still low relative to the 32.1% level experienced in the
third quarter of 1999. Annualized prepayments on Ginnie Mae ARM securities
averaged 16.9% in the third quarter of 2000, compared to 16.9% the prior quarter
and 24.4% for the same period of 1999.
The overall yield earned on the mortgage investment portfolio averaged 6.89%
during the third quarter, compared to 6.52% during the second quarter and 5.90%
during the third quarter of 1999. Overall portfolio yields continue to benefit
from increases in yields on holdings of ARM securities as interest rates on the
underlying mortgage loans reset to levels more reflective of the current
interest rate environment. In addition, third quarter yields benefited from
higher yields earned on newly acquired ARM securities and on mortgage securities
designated for sale in connection with modifying the Company's investment
strategy (see "Effects of Interest Rate Changes").
Overall financing spreads (the difference between the yield earned on mortgage
investments and the rate charged on related borrowings), although still
significantly below the 71 basis points achieved in the third quarter of 1999,
improved to 32 basis points during the current quarter from 26 basis points
during the second quarter as improving yields on the Company's mortgage
investment portfolio out-paced rising borrowing rates for the first time since
the Federal Reserve began increasing short-term interest rates in June 1999. The
Company currently expects yields on ARM securities to continue to improve in
future quarters. For example, if interest rates stabilize at current levels,
yields on the current portfolio of ARM securities could improve as much as 55
basis points over the next 12 months. Conversely, if interest rates decline,
such a yield improvement will likely not be achieved. The Company currently
anticipates the average overall yield on its mortgage investments to improve
approximately 25 basis points during the fourth quarter of 2000, while borrowing
rates are expected to average 6 basis points higher. As such, the overall
financing spread is expected to increase to approximately 51 basis points during
the fourth quarter. Actual borrowing rates will be largely dependent upon future
actions by the Federal Reserve to change short-term interest rates and the
extent of any financial market liquidity concerns.
CMO COLLATERAL AND INVESTMENTS
Since exiting the residential mortgage loan conduit business in 1995, Capstead
has maintained finance subsidiaries with capacity to issue CMOs and other
securitizations backed by single-family residential mortgage loans
("securitization shelves"). In an effort to recover costs associated with these
securitization shelves, and to potentially add to its CMO administration
activities, from time to time the Company 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. During the first quarter of 2000, Capstead
issued one such CMO totaling $236 million. The Company did not retain any
significant residual economic interest in this issuance.
To date, the related credit risk of the mortgage loans collateralizing CMOs
issued by Capstead 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 $860,000 of credit risk in the form of
subordinated
-17-
<PAGE> 18
bonds associated with approximately $520 million of these securities outstanding
as of September 30, 2000. In addition, Capstead has retained $2.8 million of
reserve funds in connection with two 1993 mortgage loan sales. These reserve
funds are available to pay special hazard costs (e.g. earthquake or
mudslide-related losses) or certain bankruptcy costs associated with
approximately $131 million of loans outstanding as of September 30, 2000 from
the related securitizations. CMO collateral and investments, net of related
bonds had been reduced to $24.1 million at quarter-end, down from $29.3 million
at December 31, 1999. Included in this net investment are $18.2 million of the
remaining CMO collateral premiums and bond discounts. Similar to 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 POTENTIAL LIQUIDITY
The following table summarizes the Company's utilization of capital and
liquidity as of September 30, 2000 (in thousands):
<TABLE>
<CAPTION>
CAPITAL
ASSETS BORROWINGS EMPLOYED LIQUIDITY *
----------- ----------- --------- -----------
<S> <C> <C> <C> <C>
Agency Securities:
FNMA/FHLMC:
Fixed-rate and medium-term $ 624,527 $ 577,164 $ 47,363 $ 28,627
ARMs 2,119,781 1,879,510 240,271 176,678
GNMA ARMs 2,302,383 2,236,312 66,071 (3,001)
Non-agency Securities 104,449 7,416 97,033 91,811
CMBS - adjustable-rate 76,012 62,874 13,138 (95)
---------- ---------- -------- ---------
5,227,152 4,763,276 463,876 294,020
CMO collateral and investments 3,224,728 3,200,624 24,104 --
---------- ---------- -------- ---------
$8,451,880 $7,963,900 487,980 294,020
========== ==========
Other assets, net of other liabilities 66,119 25,323**
-------- ---------
$554,099 $ 319,343
======== =========
</TABLE>
* Based on maximum borrowings available under existing uncommitted
repurchase arrangements considering the fair value of related
collateral as of September 30, 2000 (see "Liquidity and Capital
Resources").
** Represents unrestricted cash and cash equivalents.
1 - FOR - 2 REVERSE COMMON STOCK SPLIT
At the Company's Annual Meeting, stockholders approved a 1-for-2 reverse common
stock split. Accordingly, the Board of Directors established the close of
business on May 8, 2000 as the effective date for the reverse split. The first
day the common shares traded post-split was May 9, 2000. The reverse split
reduced the number of outstanding common shares to approximately 22.6 million.
Concurrent with the reverse split the conversion ratio for each series of
preferred shares was adjusted accordingly. All share and per share information
presented has been restated to reflect the reverse common stock split.
THIRD QUARTER COMMON DIVIDEND
On October 19, 2000 the Board of Directors declared a third quarter dividend of
$0.12 per common share, payable November 20 to stockholders of record as of
November 1, 2000.
-18-
<PAGE> 19
STOCK REPURCHASES AND BOOK VALUE PER COMMON SHARE
During the nine months ended September 30, 2000, the Company, through open
market purchases, acquired 376,950 common shares at an average price of $7.77
(including transaction costs) and 826,900 shares of its $1.26 Cumulative
Convertible Preferred Stock, Series B ("Series B preferred shares") at an
average price of $9.61 (including transaction costs). On January 25, 2000 the
Company purchased 5,568,500 common shares at a price of $9.27 per share
(including transaction costs) pursuant to a tender offer that closed on January
14, 2000. Since share repurchases began in December 1998 through September 30,
2000, the Company has repurchased 26.9% of its outstanding common shares and
8.4% of its Series B preferred shares. As of July 31, 2000, the Company had
remaining authorization to repurchase 819,300 common shares and 551,100 Series B
preferred shares.
At September 30, 2000 book value per common share was $12.51, compared to $11.66
per common share at June 30, 2000, and $11.83 per common share at December 31,
1999 (calculated assuming redemption of the Series A and B preferred shares and
conversion of the Series C and D preferred shares). The increase in book value
per common share reflects the positive impact on the value of the mortgage
investment portfolio of improving yields on ARM securities, as well as easing
inflation concerns. To a lesser extent, share repurchases also contributed to
higher book value. Although anticipated higher yields on ARM securities should
allow for further improvements in the value of these securities, the market
value of the mortgage investment portfolio will continue to fluctuate with
changes in mortgage interest rates and market liquidity, and such changes will
be reflected in book value per common share.
RESULTS OF OPERATIONS
Comparative net operating results (interest income or fee revenue, net of
related interest expense and, in the case of CMO administration, related direct
and indirect operating expense) by source were as follows (in thousands, except
per share amounts):
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------ -------------------------
2000 1999 2000 1999
------- -------- -------- --------
<S> <C> <C> <C> <C>
Agency Securities $ 7,619 $ 13,515 $ 26,756 $ 40,432
Non-agency Securities 1,800 2,717 4,982 6,858
CMBS 619 -- 1,748 --
CMO collateral and investments (375) (926) (1,182) (2,273)
------- -------- -------- --------
Net margin on mortgage assets 9,663 15,306 32,304 45,017
Other revenue (expense):
Loss on portfolio restructuring -- -- (90,008) --
Severance charges -- -- (3,607) --
Gain on sale of mortgage securities 747 -- 747 1,738
CMO administration and other 781 804 2,458 3,177
Other operating expense (1,424) (1,588) (4,709) (4,820)
------- -------- -------- --------
Net income (loss) $ 9,767 $ 14,522 $(62,815) $ 45,112
======= ======== ======== ========
Net income (loss) per common share - basic and diluted $ 0.15 $ 0.31 $ (3.50) $ 0.96
</TABLE>
The earning capacity of Capstead's mortgage asset portfolios is largely
dependent on the overall size and composition of the portfolios, the
relationship between short- and long-term interest rates (the "yield curve") and
the extent the Company continues to invest its liquidity in these portfolios.
Lower overall net margins on mortgage assets for the quarter and nine months
ended September 30, 2000 compared to the same periods in 1999 reflect higher
borrowing costs incurred financing the Company's mortgage
-19-
<PAGE> 20
investments. Borrowing costs were higher primarily because of continued actions
taken by the Federal Reserve to increase short-term interest rates by a total of
175 basis points since June 1999, including a 50 basis point increase on May 16,
2000. As a result, the Company's borrowing rates averaged 138 and 121 basis
points higher during the quarter and nine months ended September 30, 2000,
respectively, than during the same periods in 1999. These higher borrowing rates
were only partially offset by the benefits of improving yields on ARM
securities, the restructuring of the Company's mortgage investment portfolio as
a result of modifying its investment strategy (see above, "Financial Condition -
Adoption of New Investment Strategy") and relatively low mortgage asset
prepayment levels.
Agency Securities contributed less to operating results during the quarter and
nine months ended September 30, 2000 than during the same periods in 1999
because of higher borrowing costs, despite higher average yields. Yields for
this portfolio were 6.81% and 6.44% during the quarter and nine months ended
September 30, 2000, respectively, compared to 5.85% and 5.74% during the same
periods in 1999, while average borrowing rates were 6.56% and 6.21%,
respectively, compared to 5.19% and 5.01% during the same periods in 1999.
Yields benefited as interest rates on mortgage loans underlying ARM securities
continued to reset to levels more reflective of the current interest rate
environment and prepayments rates remained at relatively low levels. In
addition, current yields benefited from higher yields on newly acquired ARM
securities and on mortgage securities designated for sale in connection with the
portfolio restructuring. The average outstanding portfolio was $4.8 billion and
$5.0 billion during the quarter and nine months ended September 30, 2000,
respectively, compared to $5.6 billion and $4.7 billion for the same periods in
1999.
Non-agency Securities contributed less to operating results during the quarter
and nine months ended September 30, 2000 because of higher borrowing costs. The
average outstanding portfolio was $164 million and $170 million during the
quarter and nine months ended September 30, 2000, respectively, compared to $135
million and $116 million for the same periods in 1999, respectively. During 2000
the Company financed this portfolio with average borrowings of $85 million and
$105 million, respectively, while in 1999 the portfolio was funded almost
entirely with equity. Average yields for this portfolio (calculated including
mortgage insurance costs) were 8.00% and 7.93% during the quarter and nine
months ended September 30, 2000, respectively, compared to 8.07% and 8.02%
during the same periods in 1999.
Consistent with its new investment strategy, in December 1999 Capstead made its
first acquisitions of credit sensitive CMBS. The portfolio currently consists of
$76 million of adjustable-rate CMBS financed by longer-term repurchase
arrangements. Because of recent market conditions, the pricing for these
securities has been less attractive on a risk-adjusted return basis than other
suitable investments that are in keeping with the Company's new investment
strategy. As a result, the Company has focused on redeploying capital made
available by runoff and the portfolio restructuring into acquisitions of ARM
securities and, up to this point, has limited the growth the CMBS portfolio.
CMO collateral and investments results continue to benefit from relatively low
prepayment rates allowing remaining collateral premiums and bond discounts to be
amortized to earnings over a longer period. In addition, results for the nine
months ended September 30, 1999 included the write-off of bond discounts related
to 1999 redemptions of CMO bonds. 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.
In connection with the portfolio restructuring, in April the Company incurred a
$90.0 million charge to operating results for the sale, or designation for sale,
of most of its fixed-rate and medium-term securities. This charge consisted of
realized losses of $70.9 million and a $19.1 million reduction in basis in
securities designated for sale. Also during the second quarter the Company
incurred severance charges of
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<PAGE> 21
$3.6 million, related primarily to the resignation of its former chief executive
(see above, "Financial Condition - Election of New Leadership").
Gain on sale in the third quarter reflects the sale of $100 million of
fixed-rate Non-agency Securities. CMO administration and other revenue was lower
for the quarter and nine months ended September 30, 2000 primarily because of
declining CMO administration fee income. As the CMOs for which the Company has
CMO administration responsibilities pay down, related fee income is expected to
decline.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds include borrowings under repurchase
arrangements, monthly principal and interest payments on mortgage securities and
other investments, excess cash flows on CMO collateral and investments and
proceeds from sales of mortgage assets (see "Financial Condition - Utilization
of Capital and Liquidity"). The Company currently believes that these funds are
sufficient for the acquisition of mortgage assets, repayments on borrowings, the
payment of cash dividends as required for Capstead's continued qualification as
a Real Estate Investment Trust ("REIT") and common and preferred share
repurchases as described above. It is the Company's policy to remain strongly
capitalized and conservatively leveraged.
Borrowings under repurchase arrangements secured by Agency Securities and
Non-agency Securities generally have maturities of less than 31 days. The
Company has uncommitted repurchase facilities with investment banking firms to
finance these 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 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.
Borrowings under repurchase arrangements secured by purchases of adjustable-rate
CMBS more closely match the interest rate adjustment features and expected life
of these investments such that the Company anticipates it can earn more
consistent net interest spreads on these investments and, as a result,
experience less interest rate volatility than experienced with the Company's
other mortgage investments. Should Capstead make significant additional
investments in credit-sensitive mortgage securities, it is anticipated that the
Company will attempt to lessen interest rate volatility in a similar fashion or
through the use of derivative financial instruments ("Derivatives") such as
interest rate swaps (see "Effects of Interest Rate Changes" and "Risks
Associated With Credit-Sensitive Investments").
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 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.
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<PAGE> 22
Primarily because of the new investment strategy described above, earnings are
less sensitive to changes in interest rates at September 30, 2000 than at
December 31, 1999, as indicated in the following table:
<TABLE>
<CAPTION>
10-YEAR
30-DAY U.S.
LIBOR TREASURY IMMEDIATE CHANGE IN:
RATE RATE (RATES IN BASIS POINTS, DOLLARS IN THOUSANDS)
--------- ----------- -------------------------------------------------
* *
<S> <C> <C> <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:**
As of September 30, 2000 6.62% 5.80% $22,593 $28,856 $6,634 $(29,808)
As of December 31, 1999 5.82 6.44 31,160 36,190 5,044 (37,821)
</TABLE>
* Sensitivity of earnings to changes in interest rates is determined
relative to the actual rates at the applicable date.
** Note that the impact of actual or planned acquisitions of mortgage assets
subsequent to the indicated period-end (beyond acquisitions necessary to
replace runoff) 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 affect the Company's earnings in various ways. The
Company's earnings currently depend, in part, on the difference between the
interest received on mortgage securities and other investments, and the interest
paid on related borrowings, which are generally based on 30-day LIBOR. 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 CMT 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, 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. At September 30, 2000 the Company did not own any Derivatives as a
hedge against rising interest rates.
Another effect of changes in interest rates is that as long-term interest rates
decrease, the rate of principal prepayments on 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.
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<PAGE> 23
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 "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 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.
Capstead periodically sells mortgage assets, which may increase income
volatility because of the recognition of transactional gains or losses. 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 the mortgage asset portfolios to mitigate exposure to
further declines in mortgage interest rates or, as in the second quarter of
2000, to shift the Company's investment focus to adjustable-rate and short
maturity assets (see "Financial Condition - Adoption of New Investment
Strategy").
RISKS ASSOCIATED WITH CREDIT-SENSITIVE INVESTMENTS
CMBS are generally viewed as exposing an investor to greater risk of loss than
residential mortgage-backed securities since such securities are typically
secured by larger loans to fewer obligors than residential mortgage-backed
securities. Commercial property values and net operating income are subject to
volatility, and net operating income may be sufficient or insufficient to cover
debt service on the related mortgage loan at any given time. The repayment of
loans secured by income-producing properties is typically dependent upon the
successful operation of the related real estate project and the ability of the
applicable property to produce net operating income rather than upon the
liquidation value of the underlying real estate. Even when the current net
operating income is sufficient to cover debt service, there can be no assurance
that this will continue to be the case in the future.
Additionally, commercial properties may not readily be convertible to
alternative uses if such properties were to become unprofitable due to
competition, age of improvements, decreased demand, regulatory changes or other
factors. The conversion of commercial properties to alternate uses generally
requires substantial capital expenditures, which may or may not be available.
The availability of credit for commercial mortgage loans is significantly
dependent upon economic conditions in the markets where such properties are
located, as well as the willingness and ability of lenders to make such loans.
The availability of funds in the credit markets fluctuates and there can be no
assurance that the availability of such funds will increase above, or will not
contract below current levels. In addition, the availability of similar
commercial properties, and the competition for available credit, may affect the
ability of potential purchasers to obtain financing for the acquisition of
properties. This could effect the repayment of commercial mortgages pledged to
secure CMBS.
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<PAGE> 24
Credit-sensitive residential mortgage-backed securities differ from CMBS in
several important ways, yet can still carry substantial credit risk. Residential
mortgage securities typically are secured by smaller loans to more obligors than
CMBS, thus spreading the risk of mortgagor default. However, most of the
mortgages supporting these securities are made to homeowners that do not qualify
for Agency loan programs for reasons including loan size, financial condition,
or work or credit history that may be indicative of higher risk of default than
loans qualifying for such programs. As with CMBS, in instances of default the
Company may incur losses if proceeds from sales of the underlying collateral are
less than the unpaid principal balances of the mortgage loans and related
foreclosure costs. However, with residential mortgage-backed securities, this
risk may be mitigated by various forms of credit enhancements including, but not
limited to, primary mortgage insurance.
Through the process of securitizing both commercial and residential mortgages,
credit risk can be heightened or minimized. Senior classes in multi-class
securitizations generally have first priority over cash flows from a pool of
mortgages and, as a result, carry the least risk, highest investment ratings and
the lowest yields. Typically a securitization will also have mezzanine classes
and subordinated classes. Mezzanine classes will generally have somewhat lower
credit ratings and may have average lives that are longer than the senior
classes. Subordinate classes are junior in the right to receive cash flow from
the underlying mortgages, thus providing credit enhancement to the senior and
mezzanine classes. As a result, subordinated securities will have lower credit
ratings because of the elevated risk of credit loss inherent in these
securities.
The availability of capital from external sources to finance investments in
credit-sensitive CMBS and residential mortgage-backed securities that are not
financed to maturity at acquisition may be diminished during periods of mortgage
finance market illiquidity, such as was experienced in 1998. Additionally, if
market conditions deteriorate resulting in substantial declines in value of
these securities, sufficient capital may not be available to support the
continued ownership of such investments, requiring these securities to be sold
at a loss.
OTHER
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, deterioration in credit quality and ratings, the
effectiveness of risk management strategies, the impact of leverage, liquidity
of secondary markets and credit markets, 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."
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<PAGE> 25
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Updated information required by this Item is incorporated by reference to the
information included in Part 1. Item 1. - Financial Statements, specifically:
NOTE 12 to Consolidated Financial Statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) Exhibits: The following Exhibits are presented herewith:
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.
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<PAGE> 26
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 9, 2000 By: /s/ ANDREW F. JACOBS
-------------------------------------
Andrew F. Jacobs
Executive Vice President - Finance
Date: November 9, 2000 By: /s/ PHILLIP A. REINSCH
-------------------------------------
Phillip A. Reinsch
Senior Vice President - Control
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<PAGE> 27
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
12 Computation of Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividends.
27 Financial Data Schedule (electronic filing only).
