CMO Capstead Mortgage Corp.

Management Discussion

• ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
• Capstead operates as a self-managed REIT earning income from investing in a leveraged portfolio of residential mortgage pass-through securities consisting almost exclusively of short-duration ARM Agency Securities, which reset to more current interest rates within a relatively short period of time and are considered to have limited, if any, credit risk.  See NOTE 1 to the consolidated financial statements (included under Item 1 of this report) for defined terms used in this discussion and analysis.  By investing in short-duration ARM Agency Securities, the Company is positioned to benefit from future recoveries in financing spreads and experience smaller fluctuations in portfolio values compared to leveraged portfolios containing a significant amount of longer-duration ARM or fixed-rate mortgage securities.  Duration is a common measure of market price sensitivity to interest rate movements.  A shorter duration generally indicates less interest rate risk.
• Capstead reported for GAAP purposes a net loss of $205 million representing a loss per diluted common share of $(2.21) for the quarter ended March 31, 2020. The Company reported core earnings of $20 million or $0.16 per diluted common share for the quarter ended March 31, 2020.  See “Reconciliation of GAAP and non-GAAP Financial Measures” for more information on core earnings. The GAAP loss includes $156 million in losses on hedging-related derivatives due primarily to declining interest rates and $68 million in losses on the sale of $2.60 billion (basis) in ARM securities late in the quarter in order to ensure the Company had sufficient flexibility to meet future projected liquidity requirements while maintaining portfolio leverage at comfortable levels given disruptions experienced in the fixed income markets brought on by the novel coronavirus (“COVID-19”) pandemic. At March 31, 2020, the Company has met is liquidity requirements and given current conditions does not expect to make similar sales. GAAP and core earnings in the first quarter of 2020 benefited from lower secured borrowings rates primarily due to a total of 150 basis points in reductions in the Fed Funds rate in March and favorable terms on new interest rate swap agreements entered into during the quarter. These benefits more than offset lower portfolio yields due to lower coupon interest rates on loans underlying the Company’s ARM Agency Securities as well as changes in lifetime prepayment estimates. Book value per common share declined $2.55 per share during the quarter to $6.07 per share at March 31, 2020 primarily due to the derivative- and portfolio-related declines noted above.