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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: JUNESEPTEMBER 30, 2001
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
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) 13,849,94213,853,787 as of August 10,November 5, 2001
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CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNESEPTEMBER 30, 2001
INDEX
PAGE
----
PART I. -- FINANCIAL INFORMATION
PAGE
----
ITEM 1. Financial Statements
Consolidated Balance Sheets -- JuneSeptember 30, 2001 and December 31, 2000.....................................2000................................ 3
Consolidated Statements of Operations -- Quarter and SixNine Months Ended
JuneSeptember 30, 2001 and 2001...............................................................................2000.......................................................................... 4
Consolidated Statements of Cash Flows -- SixNine Months Ended JuneSeptember 30, 2001 and 2000.......................2000................. 5
Notes to Consolidated Financial Statements............................................................. 6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.............................................Operations................................................... 15
ITEM 3. Qualitative and Quantitative Disclosure of Market Risk...................................... 24
ITEM 4. Submission of Matters to a Vote of Security Holders.........................................Risk............................................ 25
PART II. -- OTHER INFORMATION
ITEM 2. Changes in Securities....................................................................... 26
ITEM 6. Exhibits and Reports on Form 8-K............................................................ 268-K ................................................................. 25
SIGNATURES................................................................................................ 2625
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PART I. -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
JUNESEPTEMBER 30, 2001 DECEMBER 31, 2000
------------------------------- -----------------
(UNAUDITED)
ASSETS
Mortgage investments
($4.03.6 billion pledged under repurchase arrangements) $ 4,167,8023,724,587 $ 5,394,459
CMO collateral and investments 2,770,8822,541,003 3,126,878
----------- -----------
6,938,684------------ ------------
6,265,590 8,521,337
Prepaids, receivables and other 71,84365,947 67,399
Cash and cash equivalents 115,819117,301 21,761
----------- ----------------------- ------------
$ 7,126,3466,448,838 $ 8,610,497
=========== ======================= ============
LIABILITIES
Borrowings under repurchase arrangements $ 3,938,7243,484,968 $ 4,904,632
Collateralized mortgage obligations ("CMOs") 2,750,2842,521,847 3,103,874
Accounts payable and accrued expenses 19,91815,248 31,112
----------- -----------
6,708,926------------ ------------
6,022,063 8,039,618
----------- ----------------------- ------------
PREFERRED STOCK SUBJECT TO REPURCHASE
$0.56 Cumulative Convertible Preferred Stock, Series C,
$0.10 par value; -0- and 5,378 shares authorized,
issued and outstanding JuneSeptember 30, 2001 and
December 31, 2000, respectively (converted into
common shares May 4, 2001) -- 25,210
----------- ----------------------- ------------
STOCKHOLDERS' EQUITY
Preferred stock - $0.10 par value; 100,000 shares authorized:
$1.60 Cumulative Preferred Stock, Series A,
334282 and 374 shares issued and outstanding at
JuneSeptember 30, 2001 and December 31, 2000, respectively
($5,4814,628 aggregate liquidation preference) 4,6743,947 5,228
$1.26 Cumulative Convertible Preferred Stock, Series B,
15,842 and 15,845 shares issued and outstanding at
JuneSeptember 30, 2001 and December 31, 2000, respectively
($180,285 aggregate liquidation preference) 176,987176,972 177,012
Common stock - $0.01 par value; 100,000 shares authorized;
13,78313,855 and 12,641 shares issued and outstanding at
JuneSeptember 30, 2001 and December 31, 2000, respectively 138139 126
Paid-in capital 558,639559,684 740,740
Accumulated deficit (368,207)(369,822) (396,882)
Accumulated other comprehensive income 45,18955,855 19,445
----------- -----------
417,420------------ ------------
426,775 545,669
----------- ----------------------- ------------
$ 7,126,3466,448,838 $ 8,610,497
=========== ======================= ============
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
QUARTER ENDED SIXNINE MONTHS ENDED
JUNESEPTEMBER 30 JUNESEPTEMBER 30
-------------------------- -------------------------------------------------- ------------------------
2001 2000 2001 2000
--------- --------- --------- ---------
INTEREST INCOME:
Mortgage investments $ 74,05561,033 $ 85,05886,229 $ 161,597222,630 $ 169,958256,187
CMO collateral and investments 52,410 61,739 108,195 119,66747,160 59,751 155,355 179,418
--------- --------- --------- ---------
Total interest income 126,465 146,797 269,792 289,625108,193 145,980 377,985 435,605
--------- --------- --------- ---------
INTEREST AND RELATED EXPENSE:
Borrowings under repurchase arrangements 45,670 74,300 110,831 146,20834,001 76,058 144,832 222,266
CMO borrowings 52,358 62,054 107,973 119,95747,209 59,879 155,182 179,836
Mortgage insurance and other 259 417 588 819204 380 792 1,199
--------- --------- --------- ---------
Total interest and related expense 98,287 136,771 219,392 266,98481,414 136,317 300,806 403,301
--------- --------- --------- ---------
Net margin on mortgage assets 28,178 10,026 50,400 22,64126,779 9,663 77,179 32,304
--------- --------- --------- ---------
OTHER REVENUE (EXPENSE):
Gain (loss) on sale of mortgage assets 986 (70,920) 6,849 (70,920)292 747 7,141 (70,173)
Impairment on mortgage assets -- (19,088)-- -- (19,088)
Severance costs -- (3,607)-- -- (3,607)
CMO administration and other 1,612 893 2,331 1,677683 781 3,014 2,458
Other operating expense (3,007) (1,556) (7,163) (3,285)(2,678) (1,424) (9,840) (4,709)
--------- --------- --------- ---------
Total other operating revenue (expense) (409) (94,278) 2,017 (95,223)(1,703) 104 315 (95,119)
--------- --------- --------- ---------
NET INCOME (LOSS) $ 27,76925,076 $ (84,252)9,767 $ 52,41777,494 $ (72,582)(62,815)
========= ========= ========= =========
Net income (loss) $ 27,76925,076 $ (84,252)9,767 $ 52,41777,494 $ (72,582)(62,815)
Less cash dividends paid on preferred stock (4,387) (5,723) (10,280) (11,995)(5,103) (6,372) (15,368) (18,367)
--------- --------- --------- ---------
Net income (loss) available to common stockholders $ 23,38219,973 $ (89,975)3,395 $ 42,13762,126 $ (84,577)(81,182)
========= ========= ========= =========
NET INCOME (LOSS) PER COMMON SHARE:
Basic $ 1.771.45 $ (7.97)0.30 $ 3.274.71 $ (7.21)(7.01)
Diluted 1.63 (7.97) 3.01 (7.21)1.27 $ 0.30 4.22 $ (7.01)
CASH DIVIDENDS DECLARED PER SHARE:
Common - regular quarterly $ 1.5601.500 $ 0.3200.240 $ 2.5404.040 $ 0.7601.000
Common - special 14.600-- -- 14.600 --
Series A Preferred 0.400 0.400 0.800 0.8001.200 1.200
Series B Preferred 0.315 0.315 0.630 0.6300.945 0.945
Series C Preferred (converted into common shares May 4, 2001) -- 0.140 -- 0.2800.420
Series D Preferred (converted into common shares December 28, 2000) -- 0.100 -- 0.2000.300
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIXNINE MONTHS ENDED
JUNESEPTEMBER 30
--------------------------------------------------------------
2001 2000
----------- ------------------------ -------------
OPERATING ACTIVITIES:
Net income (loss) $ 52,41777,494 $ (72,582)(62,815)
Noncash items:
Amortization of discount and premium 16,296 9,86124,548 12,960
Depreciation and other amortization 553 467863 741
(Gain) loss on sale of mortgage assets (6,849) 70,920(7,141) 70,173
Impairment on mortgage assets -- 19,088
Net change in prepaids, receivables, other assets,
accounts payable and accrued expenses (14,208) (9,590)
----------- -----------(13,265) (9,707)
------------- -------------
Net cash provided by operating activities 48,209 18,164
----------- -----------82,499 30,440
------------- -------------
INVESTING ACTIVITIES:
Purchases of mortgage investments (110,480) (1,203,840)(126,022) (1,913,604)
Purchases of CMO collateral and investments -- (235,999)
Principal collections on mortgage investments 876,805 426,2781,344,015 681,173
Proceeds from sale of mortgage assets 540,862 1,303,638556,165 1,404,321
CMO collateral:
Principal collections 293,134 210,956502,482 326,283
Decrease in accrued interest receivable 2,228 1,4073,650 2,107
Decrease (increase) in short-term investments (337) 64
----------- -----------(321) 178
------------- -------------
Net cash provided by investing activities 1,602,212 502,504
----------- -----------2,279,969 264,459
------------- -------------
FINANCING ACTIVITIES:
Decrease in borrowings under repurchase arrangements (965,908) (477,665)(1,419,664) (109,116)
CMO borrowings:
Issuance of securities -- 235,999
Principal payments on securities (356,325) (215,273)(585,384) (332,174)
Decrease in accrued interest payable (2,443) (1,248)(3,769) (1,783)
Capital stock transactions (207,945) (62,594)(207,657) (64,076)
Dividends paid (23,742) (16,964)
----------- -----------(50,454) (26,914)
------------- -------------
Net cash used in financing activities (1,556,363) (537,745)
----------- -----------(2,266,928) (298,064)
------------- -------------
Net change in cash and cash equivalents 94,058 (17,077)95,540 (3,165)
Cash and cash equivalents at beginning of period 21,761 28,488
----------- ------------------------ -------------
Cash and cash equivalents at end of period $ 115,819117,301 $ 11,411
=========== ===========25,323
============= =============
See accompanying notes to consolidated financial statements.
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CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNESEPTEMBER 30, 2001
(UNAUDITED)
NOTE 1 -- BUSINESS
Capstead Mortgage Corporation ("Capstead" or the "Company") operates as a real
estate investment trust ("REIT") earning income from investing in real
estate-related assets on a leveraged basis and from other investment strategies.
These investments currently include, but are not limited to, adjustable-rate
single-family residential mortgage-backed securities issued by
government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae
("Agency Securities"). The Company is also evaluating other suitable investments
which may include credit-sensitive commercial and residential real
estate-related assets.
NOTE 2 -- BASIS OF PRESENTATION
Basis of Presentation of Interim Financial Information. The accompanying
unaudited consolidated financial statements have been prepared in accordance
with accounting principles generally accepted accounting principlesin the United States 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 accounting principles generally accepted accounting principlesin the United
States for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the quarter ended
JuneSeptember 30, 2001 are not necessarily indicative of the results that may be
expected for the calendar year ending December 31, 2001. 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, 2000.
1-For-2 Reverse Common Stock Split. All references to common shares and per
common share amounts have been adjusted to reflect a 1-for-2 reverse common
stock split which was approved at a special stockholders meeting held June 15,
2001. The common shares commenced trading on a post-reverse split basis on July
2, 2001, which coincided with the first day the common shares traded ex-dividend
for a $14.60 ($7.30 pre-reverse split) special common dividend paid June 29,
2001 (see NOTE 3)4).
Adoption of New Derivative Financial Instrument Accounting Rules. Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133") establishes new accounting and reporting
standards for derivative financial instruments ("Derivatives") and hedging
activities. It requires recognition of all Derivatives, including certain
Derivatives not previously afforded accounting recognition, as either assets or
liabilities on the balance sheets and measurement of those instruments at fair
value. The Company adopted SFAS 133 January 1, 2001 and recognized in Other
comprehensive income as cash flow hedge instruments certain clean-up call rights
on off-balance sheet
securitizations previously issued by the Company that were originally
accounted for as cash flow hedge instrumentssales (see NOTE 10). These call rights allow Capstead to lock
in a maximum price for a modest amount of adjustable-rate mortgage-backed
securities that the Company expects to purchase in the future, provided certain
requirements specified in the related indentures have been met.
NOTE 3 -- 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
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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 were as follows (in
thousands, except per share data):
QUARTER ENDED JUNE 30 SIXNINE MONTHS ENDED
JUNE-------------------------- --------------------------
SEPTEMBER 30 ------------------------ ------------------------SEPTEMBER 30
-------------------------- --------------------------
2001 2000 2001 2000
-------- -------- -------- ------------------ ---------- ---------- ----------
NUMERATOR FOR BASIC NET INCOME (LOSS) PER COMMON SHARE:
Net income (loss) $ 27,769 $(84,252)25,076 $ 52,417 $(72,582)9,767 $ 77,494 $ (62,815)
Less all preferred share dividends* (4,387) (5,723) (10,280) (11,995)
-------- -------- -------- --------dividends (5,103) (6,372) (15,368) (18,367)
---------- ---------- ---------- ----------
Net income (loss) available to common stockholders $ 23,382 $(89,975)19,973 $ 42,137 $(84,577)
======== ======== ======== ========3,395 $ 62,126 $ (81,182)
========== ========== ========== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 13,213 11,294 12,887 11,72613,793 11,295 13,192 11,581
BASIC NET INCOME (LOSS) PER COMMON SHARE $ 1.771.45 $ (7.97)0.30 $ 3.274.71 $ (7.21)(7.01)
NUMERATOR FOR DILUTED NET INCOME (LOSS) PER COMMON SHARE:
Net income (loss) $ 27,769 $(84,252)25,076 $ 52,417 $(72,582)9,767 $ 77,494 $ (62,815)
Less cash dividends paid on antidilutive
convertible preferred shares:
Series A -- (150) -- (299)(449)
Series B (4,990) (5,093)-- (5,017) (9,981) (10,315)(15,332)
Series B repurchase amounts less than book value -- 81186 -- 1,2001,286
Series C (converted into common shares May 4, 2001) -- (753) -- (1,506)(2,259)
Series D (converted into common shares December 28, 2000) -- (538) -- (1,075)
-------- -------- -------- --------(1,613)
---------- ---------- ---------- ----------
$ 22,779 $(89,975)25,076 $ 42,436 $(84,577)
======== ======== ======== ========3,395 $ 67,513 $ (81,182)
========== ========== ========== ==========
DENOMINATOR FOR DILUTED NET INCOME (LOSS) PER COMMON SHARE:
Weighted average common shares outstanding 13,213 11,294 12,887 11,72613,793 11,295 13,192 11,581
Net effect of dilutive stock options 75 -- 7988 38 82 --
Net effect of dilutive preferred shares 689** 5,863 -- 1,1182,717 --
-------- -------- -------- --------
13,977 11,294 14,084 11,726
======== ======== ======== ========---------- ---------- ---------- ----------
19,744 11,333 15,991 11,581
========== ========== ========== ==========
DILUTED NET INCOME (LOSS) PER COMMON SHARE**SHARE $ 1.631.27 $ (7.97)0.30 $ 3.014.22 $ (7.21)(7.01)
* Included in second quarter 2001 preferred share dividends is the recovery
of first quarter 2001 Series C preferred dividends upon conversion of these
shares into common shares. Included in preferred share dividends during
2000 is the difference between repurchase amounts and the Series B
preferred share book value of $11.17 per share.
** See NOTE 4 for discussion regarding adjustments to preferred share
conversion rates that willhave an impact future calculationson the calculation of diluted earningsnet
income per share.common share for current and future quarters and corresponding
year-to-date periods.
NOTE 4 -- CAPITAL TRANSACTIONS
SecondThird Quarter Common Dividend. On JulyOctober 18, 2001 the Board of Directors
declared a secondthird quarter dividend of $1.56$1.50 per common share, payable AugustNovember 20
to stockholders of record as of August 9,November 5, 2001.
Special Common Dividend. On April 30, 2001 the Board of Directors declared a
special dividend of $14.60 per common share, or $201.2 million of the Company's
Paid-in capital, which was paid June 29 to stockholders of record as of June 13,
2001.
Conversion of Series C Preferred Shares. On May 4, 2001 Fortress Investment
Group LLC ("Fortress") converted the Series C preferred shares it acquired
through an affiliate in December 1999, into 1,344,500 common shares. Fortress
controls 34% of the voting shares of the Company. Wesley R. Edens, Capstead's
Chairman of the Board and Chief Executive Officer, is also chairman of the board
of Fortress.
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Adjustments to Preferred Share Conversion Rates. As a consequence of the special
common dividend and reverse stock split, the conversion rates of the Series A
and B preferred shares were adjusted concurrently in accordance with the terms
of the governing Articles Supplementary, as follows:
PREFERRED SHARES PRIOR RATES NEW RATES
---------------- ----------- ---------
Series A 0.5525 0.9657
Series B 0.1922 0.3559
At the current market prices of both the common shares and Series B preferred
shares, few, if any, actual Series B conversions are expected. The new
conversion rate for the Series B preferred shares does however increase this
security's dilutive effect in the calculation of dilutive earningsnet income per common
share. The Series B preferred shares are considered dilutive, for earningsdiluted net
income per share purposes only, whenever the annualized common basic earningsnet income per
share exceeds $3.54 ($1.26 Series B annualized dividend divided by the new
conversion rate of 0.3559). Consequently, for earningsdiluted net income per share
calculation purposes only, the Company currently expects the Series B preferred shares were dilutive in the
third quarter and are expected to be dilutive in the third and fourth quartersquarter of 2001.
Because significant levels of Series B preferred share conversions are not
expected, REIT distribution requirements per common share should not be
affected.
NOTE 5 -- MORTGAGE INVESTMENTS
Mortgage investments and the related average effective interest rates were as
follows (dollars in thousands):
AVERAGE
PRINCIPAL PREMIUMS CARRYING AVERAGE EFFECTIVE
BALANCE (DISCOUNT) BASIS AMOUNT COUPON RATE
----------- ----------- ----------- ----------- ------- -------------------- -----------
* ** **
JUNESEPTEMBER 30, 2001 * ** **
Agency Securities:
Fannie Mae/Freddie Mac:
Fixed-rate $ 2,9786,039 $ 1436 $ 2,9926,075 $ 3,1806,250 10.00% 9.54%9.64%
Medium-term 91,932 195 92,127 93,468 6.36 6.0677,889 142 78,031 79,663 6.37 5.87
LIBOR/CMT ARMs 1,890,167 32,428 1,922,595 1,941,102 7.87 6.781,672,498 28,305 1,700,803 1,722,031 7.38 6.33
COFI ARMs 192,179 (4,794) 187,385 194,100 6.58 6.67178,158 (4,910) 173,248 181,053 5.89 5.90
Ginnie Mae ARMs 1,755,912 17,231 1,773,143 1,787,333 7.01 6.511,543,185 15,881 1,559,066 1,579,787 6.70 6.14
----------- ----------- ----------- ----------- ----- -----
3,933,168 45,074 3,978,242 4,019,183 7.39 6.64----------- -----------
3,477,769 39,454 3,517,223 3,568,784 6.99 6.22
Non-agency securities 74,860 46 74,906 76,295 7.97 7.9482,236 402 82,638 84,152 7.46 7.18
CMBS - adjustable-rate 72,189 (490) 71,699 72,324 5.95 7.0971,533 (390) 71,143 71,651 5.22 6.19
----------- ----------- ----------- ----------- ----- ---------------- -----------
$ 4,080,2173,631,538 $ 44,63039,466 $ 4,124,8473,671,004 $ 4,167,802 7.37% 6.68%3,724,587 6.96% 6.24%
=========== =========== =========== =========== ===== ================ ===========
DECEMBER 31, 2000
Agency Securities:
Fannie Mae/Freddie Mac:
Fixed-rate $ 3,411 $ 16 $ 3,427 $ 3,646 10.00% 9.73%
Medium-term 586,954 (5,357) 581,597 585,756 6.19 7.00
LIBOR/CMT ARMs 2,176,060 40,140 2,216,200 2,225,118 8.19 7.11
COFI ARMs 209,721 (4,957) 204,764 208,672 6.78 7.58
Ginnie Mae ARMs 2,181,958 18,323 2,200,281 2,199,649 7.07 6.92
----------- ----------- ----------- ----------- ----- ---------------- -----------
5,158,104 48,165 5,206,269 5,222,841 7.43 7.03
Non-agency securities 94,538 -- 94,538 96,390 8.44 8.21
CMBS - adjustable-rate 74,920 (688) 74,232 75,228 8.68 9.35
----------- ----------- ----------- ----------- ----- ---------------- -----------
$ 5,327,562 $ 47,477 $ 5,375,039 $ 5,394,459 7.47% 7.09%
=========== =========== =========== =========== ===== ================ ===========
* Includes mark-to-market for securities classified as available-for-sale, if
applicable (see NOTE 9).
** Average Coupon is presented as of the indicated balance sheet date. Average
Effective Rate is presented for the quarter then ended, calculated
including mortgage insurance costs on non-agency securities and excluding
unrealized gains and losses.
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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 3 or 5 years after
origination, based on a specified margin over Fannie Mae yields for 30-year,
fixed-rate commitments 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 annually
based on a specified margin over 1-year CMT, (ii) adjust semiannually based on a
specified margin over the 6-month London Interbank Offered Rate ("LIBOR"), (iii)
adjust monthly based on a specific margin over the Cost of Funds Index ("COFI")
as published by the Eleventh District Federal Reserve Bank, or (iv) were
previously classified as medium-term and have begun adjusting annually based on
a specified margin over 1-year CMT. CMBS held as of JuneSeptember 30, 2001 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
JuneSeptember 30, 2001 carry credit risk associated with the underlying commercial
mortgage loans. This risk is mitigated by bonds held by other investors that are
subordinate to the Company's interests. 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 either Agency Securities or 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 $630,000$543,000 of credit risk in the form of subordinated bonds
associated with approximately $456$259 million of Pledged CMO Collateral remaining
outstanding as of JuneSeptember 30, 2001.
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 $116$106 million of loans remaining
outstanding as of JuneSeptember 30, 2001 from the related securitizations.
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The components of CMO collateral and investments were as follows (in thousands):
JUNESEPTEMBER 30, 2001 DECEMBER 31, 2000
------------------------------ -----------------
Pledged CMO Collateral:
Pledged mortgage securities $2,734,816 $3,088,579$ 2,507,031 $ 3,088,579
Short-term investments 829812 491
Accrued interest receivable 16,44715,025 18,675
---------- ----------
2,752,092---------------- ----------------
2,522,868 3,107,745
Unamortized premium 16,00615,287 16,322
---------- ----------
2,768,098---------------- ----------------
2,538,155 3,124,067
CMO investments 2,7842,848 2,811
---------- ----------
$2,770,882 $3,126,878
========== ==========---------------- ----------------
$ 2,541,003 $ 3,126,878
================ ================
The weighted average effective interest rate for total Pledged CMO Collateral
was 7.27%7.17% during the quarter ended JuneSeptember 30, 2001.
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 longer maturities.
The terms and conditions of these arrangements are negotiated on a
transaction-by-transaction basis. Repurchase arrangements and related weighted
average effective interest rates, classified by type of collateral and
maturities, were as follows (dollars in thousands):
JUNESEPTEMBER 30, 2001 DECEMBER 31, 2000
------------------------ ----------------------------------------------------- ---------------------------
BORROWINGS AVERAGE BORROWINGS AVERAGE
OUTSTANDING RATE OUTSTANDING RATE
------------- ----------- ------------------- ----------- -------
Agency Securities (less than 31 days) $3,406,576 3.86%$3,361,813 3.10% $4,616,784 6.58%
Agency Securities (31 to 90 days) 400,999 3.71- - 218,104 6.55
Non-agency Securities (less than 31 days) 71,294 3.7863,838 2.78 6,947 6.90
CMBS (less than 1 year) 59,855 4.4959,317 3.89 49,145 7.25
CMBS (over 1 year) -- -- 13,652 7.25
---------- ---- ---------- ----
$3,938,724 3.85%$3,484,968 3.10% $4,904,632 6.59%
========== ==== ========== ====
The weighted average effective interest rate on borrowings under repurchase
arrangements was 4.43%3.64% during the quarter ended JuneSeptember 30, 2001.
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.
-10-
11
The components of CMOs along with selected other information are summarized as
follows (dollars in thousands):
JUNESEPTEMBER 30, 2001 DECEMBER 31, 2000
------------------------------- -----------------
CMOs $2,732,472$2,504,375 $3,087,167
Accrued interest payable 15,32513,999 17,768
---------- ----------
Total obligation 2,747,7972,581,374 3,104,935
---------- ----------
Unamortized discount 2,487premium (discount) 3,473 (1,061)
---------- ----------
$2,750,284$2,521,847 $3,103,874
========== ==========
Range of average interest rates 4.17%3.21% to 9.45%9.48% 4.95% to 9.45%
Range of stated maturities 2008 to 2030 2008 to 2030
Number of series 2220 26
The maturity of each CMO series is directly affected by the rate of principal
prepayments on the related Pledged CMO Collateral. Each series is also subject
to redemption, generally at the Company's option, provided that certain
requirements specified in the related indenture have been met (referred to as
"Clean-up Calls"); therefore, the actual maturity of any series is likely to
occur earlier than its stated maturity. The average effective interest rate for
all CMOs was 7.31%7.21% during the quarter ended JuneSeptember 30, 2001.
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):
GROSS GROSS
COST UNREALIZED UNREALIZED FAIR
BASIS GAINS LOSSES VALUE
---------- ---------- ---------- ----------
AS OF JUNESEPTEMBER 30, 2001
Agency Securities:
Fixed-rate $ 2,9922,771 $ 188175 $ -- $ 3,1802,946
Medium-term 92,127 1,34178,031 1,632 -- 93,46879,663
ARMs 3,883,123 40,459 1,047 3,922,5353,433,117 49,935 181 3,482,871
---------- ------- ---- ----------
---------- ----------
3,978,242 41,988 1,047 4,019,1833,513,919 51,742 181 3,565,480
Non-agency Securities 73,721 1,39081,462 1,514 -- 75,11182,976
CMBS - adjustable-rate 71,699 62571,143 508 -- 72,32471,651
CMO collateral and investments 63,297 1,279 69 64,50750,996 1,309 32 52,273
---------- ------- ---- ----------
---------- ----------
$4,186,959 $ 45,282 $ 1,116 $4,231,125$3,717,520 $55,073 $213 $3,772,380
========== ========== ================= ==== ==========
-11-
12
GROSS GROSS
COST UNREALIZED UNREALIZED FAIR
BASIS GAINSGAIN LOSSES VALUE
---------- ---------- ---------- ----------
AS OF DECEMBER 31, 2000
Agency Securities:
Fixed-rate $ 3,427 $ 219 $ -- $ 3,646
Medium-term 581,597 5,176 1,017 585,756
ARMs 4,621,245 20,165 7,971 4,633,439
---------- ---------- ----------------- ------ ----------
5,206,269 25,560 8,988 5,222,841
Non-agency Securities 94,538 1,852 -- 96,390
CMBS - adjustable-rate 74,232 996 -- 75,228
CMO collateral and investments 74,648 196 171 74,673
---------- ---------- ----------------- ------ ----------
$5,449,687 $ 28,604 $ 9,159$28,604 $9,159 $5,469,132
========== ========== ================= ====== ==========
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. Fair value disclosures for debt securities
held-to-maturity were as follows (in thousands):
GROSS GROSS
COST UNREALIZED UNREALIZED FAIR
BASIS GAINS LOSSES VALUE
---------- ---------- ---------- ----------
AS OF JUNESEPTEMBER 30, 2001
Non-agencyReleased CMO Collateral:
Agency Securities $ 1,1853,304 $ 80201 $ -- $ 1,2653,505
Non-agency Securities 1,176 84 -- 1,260
Pledged CMO Collateral 2,706,375 1,543 12,384 2,695,5342,488,730 1,410 11,344 2,478,796
---------- ------ ------- ----------
---------- ----------
$2,707,560 $ 1,623 $ 12,384 $2,696,799$2,493,210 $1,695 $11,344 $2,483,561
========== ========== ================ ======= ==========
AS OF DECEMBER 31, 2000
Pledged CMO Collateral $3,052,205 $ 1,204 $ 14,326$1,204 $14,326 $3,039,083
========== ========== ================ ======= ==========
Sales of released CMO collateral occasionally occur provided the collateral has
paid down to within 15% of its original issuance amounts. Dispositions of debt
securities were as follows (in thousands):
QUARTER ENDED JUNE 30 SIXNINE MONTHS ENDED
JUNESEPTEMBER 30 ----------------------------- -----------------------------SEPTEMBER 30
---------------------- ---------------------
2001 2000 2001 2000
----------- ----------- ----------- ------------------- ---------- --------- ---------
Sale of securities held available-for-sale:
Amortized cost $ -- $ 1,374,558 $ 451,319 $ 1,374,55815,010 $474,441 $1,389,568
Gain (loss) -- (70,920) 5,863 (70,920)(69) 6,210 (70,989)
Sale of released CMO collateral held-to-maturity:
Amortized cost 82,958 -- 82,958 --15,013 84,547 74,849 84,547
Gain 986 -- 986 --292 816 931 816
-12-
13
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
provides information regarding comprehensive income (loss) (in thousands):
QUARTER ENDED SIXNINE MONTHS ENDED
JUNESEPTEMBER 30 JUNESEPTEMBER 30
------------------------ ------------------------------------------- ---------------------
2001 2000 2001 2000
-------- -------- --------------- --------- --------
Net income (loss) $ 27,769 $(84,252)25,076 $ 52,417 $(72,582)9,767 $ 77,494 $(62,815)
-------- ------- --------- --------
Other comprehensive income (loss):income:
Unrealized gain (loss) on Derivatives
held as cash flow hedges:
Initial gain upon adoption of SFAS 133 -- -- 1,365 --
Change in unrealized gain (loss) during period 54(17) -- (318)(335) --
Reclassification adjustment for (gain) lossgain
included in net income (loss) (11) -- (24)(35) --
-------- ------- --------- --------
-------- --------
43(28) -- 1,023995 --
Unrealized gain (loss) on debt securities:
Change in unrealized gain (loss) during period 4,832 (8,636) 30,584 (20,345)10,693 23,712 41,278 3,367
Reclassification adjustment for (gain) loss
included in net income (loss) -- 90,00869 (5,863) 90,00890,077
-------- -------- --------------- --------- --------
Other comprehensive income (loss) 4,875 81,372 25,744 69,66310,665 23,781 36,410 93,444
-------- -------- --------------- --------- --------
Comprehensive income (loss) $ 32,64435,741 $33,548 $ (2,880)113,904 $ 78,161 $ (2,919)30,629
======== ======== =============== ========= ========
NOTE 11 -- NET INTEREST INCOME ANALYSIS
The following tables summarize interest income and interest expense and weighted
average interest rates (dollars in thousands):
QUARTER ENDED JUNESEPTEMBER 30
------------------------------------------------------------------------------------------------------
2001 2000
-------------------------- --------------------------------------------- -------------------
AMOUNT AVERAGE AMOUNT AVERAGE
-------- ----------- -------- ------------------- --------
Interest income:
Interest income:
Mortgage investments $ 74,055 6.68%61,033 6.24% $ 85,058 6.52%86,229 6.89%
CMO collateral and investments 52,410 7.27 61,739 7.3747,160 7.16 59,751 7.32
-------- --------
Total interest income 126,465 146,797108,193 145,980
-------- --------
Interest expense:
Borrowings under repurchase arrangements 45,670 4.43 74,300 6.2634,001 3.64 76,058 6.57
CMO borrowings 52,358 7.31 62,054 7.4747,209 7.21 59,879 7.39
-------- --------
Total interest expense 98,028 136,35481,210 135,937
-------- --------
$ 28,43726,983 $ 10,44310,043
======== ========
SIXNINE MONTHS ENDED JUNESEPTEMBER 30
-------------------------------------------------------------------------------------------------------
2001 2000
--------------------------- ---------------------------------------------- -------------------
AMOUNT AVERAGE AMOUNT AVERAGE
-------- ------- -------- -------
Interest income:
Mortgage investments $161,597 6.89% $169,958 6.37%$222,630 6.69% $256,187 6.54%
CMO collateral and investments 108,195 7.30 119,667 7.23155,355 7.27 179,418 7.27
-------- --------
Total interest income 269,792 289,625377,985 435,605
-------- --------
Interest expense:
Borrowings under repurchase arrangements 110,831 5.15 146,208 6.05144,832 4.69 222,266 6.22
CMOs borrowings 107,973 7.33 119,957155,182 7.30 179,836 7.34
-------- --------
Total interest expense 218,804 266,165300,014 402,102
-------- --------
$ 50,98877,971 $ 23,46033,503
======== ========
-13-
14
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):
QUARTER ENDED JUNESEPTEMBER 30, 2001
-------------------------------------------------------------------------
RATE* VOLUME* TOTAL
-------- --------------- --------- --------
Interest income:
Mortgage investments $ 1,881 $(12,884) $(11,003)(7,613) $(17,583) $(25,196)
CMO collateral and investments (876) (8,453) (9,329)(1,280) (11,311) (12,591)
-------- -------- --------
Total interest income 1,005 (21,337) (20,332)(8,893) (28,894) (37,787)
-------- -------- --------
Interest expense:
Borrowings under repurchase arrangements (19,658) (8,972) (28,630)(29,368) (12,689) (42,057)
CMO borrowings (1,297) (8,399) (9,696)(1,442) (11,228) (12,670)
-------- -------- --------
Total interest expense (20,955) (17,371) (38,326)(30,810) (23,917) (54,727)
-------- -------- --------
$ 21,96021,917 $ (3,966)(4,977) $ 17,99416,940
======== ======== ========
SIXNINE MONTHS ENDED JUNESEPTEMBER 30, 2001
----------------------------------------------------------------------------
RATE* VOLUME* TOTAL
-------- --------------- --------- --------
Interest income:
Mortgage investments $ 13,239 $(21,600)6,269 $(39,826) $ (8,361)(33,557)
CMO collateral and investments 1,133 (12,605) (11,472)-- (24,063) (24,063)
-------- -------- -----------------
Total interest income 14,372 (34,205) (19,833)6,269 (63,889) (57,620)
-------- -------- -----------------
Interest expense:
Borrowings under repurchase arrangements (20,219) (15,158) (35,377)(49,558) (27,876) (77,434)
CMO borrowings 475 (12,459) (11,984)(1,096) (23,558) (24,654)
-------- -------- -----------------
Total interest expense (19,744) (27,617) (47,361)(50,654) (51,434) (102,088)
-------- -------- -----------------
$ 34,11656,923 $(12,455) $ (6,588) $ 27,52844,468
======== ======== =================
* 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. 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 amended complaint
claims that as a result of alleged improper actions, the market prices of the
Company's equity securities were artificially inflated during the period between
April 17, 1997 and June 26, 1998. The amended complaint seeks monetary damages
in an undetermined amount. On February 20, 2001 the Company responded to this
amended complaint with a motion to dismiss all allegations against the Company
and the named officers. On April 20, 2001 the plaintiffs responded to the
Company's motion to dismiss. The Company filed its reply to the plaintiffs'
response on May 21, 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.
-14-
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FINANCIAL CONDITION
Capstead Mortgage Corporation ("Capstead" or the "Company") operates as a real
estate investment trust ("REIT") earning income from investing in real
estate-related assets on a leveraged basis and from other investment strategies.
These investments currently include, but are not limited to, adjustable-rate
single-family residential mortgage-backed securities issued by
government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae
("Agency Securities"). Capstead is also evaluating other suitable investments
which may include credit-sensitive commercial and residential real
estate-related assets.
On April 30, 2001 the Company declared a $14.60 per common share special
dividend that was paid June 29, 2001. The special dividend reduced common equity
capital by $201.2 million, or nearly 50% to $201.2 million;, creating a capital structure capable
of generating enhanced returns to common equity stockholders, particularly under
current market conditions.stockholders. No asset sales
were necessary to fund the dividend.
In conjunction with the special dividend, on June 15, 2001 stockholders approved
a 1-for-2 reverse common stock split. The common shares began trading on a
post-reverse split basis on July 2, 2001, which coincided with the first day the
common shares traded ex-special dividend. All references to common shares and
per common share amounts have been adjusted to reflect the reverse split.
BookAfter the payment of the special common dividend, the Company's book value per
common share ended the third quarter 2001 at $14.68 (calculated assuming payment
of $13.96the $1.50 third quarter 2001 common dividend declared October 18, 2001, and
the redemption of the Series A and B preferred shares). This compares to $26.22
book value per common share at June 30, 2001 ($28.56 afterDecember 31, 2000. Again assuming payment of
regular quarterly common dividends, but adding back the $14.60 special common dividend,
paid June 29),this represents an increaseimprovement in book value of $2.34 from$3.06 per common share since
year-end, 2000 (calculated assuming payment of the second quarter 2001
common dividend, and redemption of outstanding preferred shares). Book value
benefited fromlargely attributable to the positive impact on the market value of the
Company's mortgage assetsinvestment portfolio from lower prevailing interest rates, offset to some extent by
portfolio runoff. Book value also benefited during 2001 from $6.8$7.1 million of
undistributed gainsgain on mortgage asset sales and, to a lesser extent, a March
tender for 275,845 common shares at a price of $26.50 per share (including
transaction costs). The market value of Capstead's mortgage assets will continue
to fluctuate with changes in interest rates and market liquidity, and such
changes will generally be reflected in book value per common share. Book value
will also be affected by other factors, including the level of dividend
distributions and the size and composition of the Company's investment
portfolios.
On May 4, 2001 Fortress Investment Group LLC ("Fortress") converted the Series C
preferred shares it acquired through an affiliate in December 1999, into
1,344,500 common shares. Fortress controls 34% of the voting shares of the
Company. Wesley R. Edens, Capstead's Chairman of the Board and Chief Executive
Officer, is also chairman of the board of Fortress.
MORTGAGE INVESTMENTS
Mortgage investments consist primarily of single-family residential
mortgage-backed securities, most of which are adjustable-rate mortgage ("ARM")
Agency Securities (see NOTE 5 to the accompanying consolidated financial
statements for discussion of how Capstead classifies its mortgage investments).
Agency Securities are AAA-rated and have no foreclosure risk. 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"Non-
-15-
agency Securities"). The Company also invests in credit-sensitive commercial
mortgage assets such as commercial mortgage-backed securities ("CMBS"). Although
currently investment grade, these
-15-
16 securities carry credit risk associated with
the underlying commercial mortgage loans. This risk is mitigated by bonds held
by other investors that are subordinate to the Company's interest (see "Risks
Associated With Credit-Sensitive Investments").
The Company's mortgage investment portfolio declined during the first nine
months of 2001 to $4.2$3.7 billion from $5.4 billion at year-endDecember 31, 2000 as a
result of portfolio runoff and the first quarter sale of $451 million of
medium-term securities. Additions to the portfolio wereduring 2001 have been limited
to $87$102 million of ARM securities acquired in January.securities. To the extent proceeds of runoff or asset
sales are not reinvested or cannot be reinvested at a rate of return at least
equal to the rate previously earned on that capital, earnings may decline. The
Company continues to evaluate suitable real estate-related investments, which
may include credit-sensitive assets that generally earn higher yields due
largely to a higher risk of default and reduced liquidity. Capstead believes
that such investments, when combined with the prudent use of leverage, can
provide attractive returns over the long term. The future size and composition
of Capstead's mortgage investment portfolio will depend on market conditions,
including levels of mortgage prepayments and the availability of suitable
investments at attractive pricing (see "Effects of Interest Rate Changes").
The following yield and cost analysis illustrates results achieved during the
secondthird quarter 2001 for each component of the mortgage investment portfolio and
anticipated thirdfourth quarter 2001 asset yields and borrowing rates as first
projected by the Company on JulyOctober 18, 2001 (the date secondthird quarter 2001
results were released and based on interest rates in effect at that date)
(dollars in thousands):
2ND3RD QUARTER AVERAGE AS OF JUNESEPTEMBER 30, 2001
------------------------------------------ -------------------------------------------------------------- ------------------------- PROJECTED LIFETIME
ACTUAL ACTUAL PREMIUMS 3RD4TH QUARTER PREPAYMENT
BASIS YIELD/COST RUNOFF (DISCOUNTS) BASIS YIELD/COST ASSUMPTIONS
----------------------- ---------- ----------- ----------- -------------------- ----------- ------------ (a) (a) (b) (b)----------- ------------
* * ** **
Agency securities:
Fannie Mae/Freddie Mac:
Fixed-rate $ 3,182 9.54% 38%5,170 9.64% 22% $ 1436 $ 2,992 9.66%6,075 9.68% 25%
Medium-term 98,12086,038 5.87 48 142 78,031 6.06 33 195 92,127 6.08 25
ARMs:
LIBOR/CMT 2,047,490 6.78 35 32,428 1,922,595 6.401,816,116 6.33 39 28,305 1,700,803 5.94 40
COFI 194,650 6.67 20 (4,794) 187,385 5.95 15181,658 5.90 26 (4,910) 173,248 5.44 18
Ginnie Mae ARMs 1,915,508 6.51 43 17,231 1,773,143 6.271,671,211 6.14 40 15,881 1,559,066 5.81 26
---------- ---------- ------- ----------- ---- ----------- ----------- ----------- ---- -----------
4,258,950 6.64 38 45,074 3,978,242 6.31---------- ---------- --
3,760,193 6.22 39 39,454 3,517,223 5.87 32
Non-agency securities 101,021 7.94 42 46 74,906 7.5477,433 7.18 32 402 82,638 6.99 30
CMBS - adjustable-rate 72,180 7.09 9 (490) 71,699 6.6671,527 6.19 4 (390) 71,143 5.38 --
---------- ---------- ------- ----------- ---- ----------- ----------- ----------- ---- -----------
4,432,151 6.68---------- ---------- --
3,909,153 6.24 38% $ 44,630 4,124,847 6.3439,466 3,671,004 5.88 32%
======= =========== =========== =============
Borrowings (4,074,044) 4.43 (3,938,724) 3.83
----------- ---- ----------- ----3,656,146 3.64 3,484,968 2.66
---------- ---------- ---------- ----------
Capital employed/
financing spread $ 358,107 2.25%253,007 2.60% $ 186,123 2.51%
=========== ==== =========== ====186,036 3.22%
========== ========== ========== ==========
Return on assets (c) 2.55% 2.72%
==== ====*** 2.76% 3.39%
========== ==========
(a)* Basis represents the Company's investment before mark-to-market.
(b)** Projected yields for the thirdfourth quarter 2001 reflect ARM coupon resets and
lifetime prepayment assumptions as adjusted for expected prepayments for
this quarter only, as of JulyOctober 18, 2001. Actual yields realized in
future periods will largely depend upon (i) changes in portfolio
composition, (ii) actual ARM coupon resets, (iii) actual prepayments and
(iv) any changes in lifetime prepayment assumptions. Actual net margin on
mortgage assets is also dependent on portfolio size and the extent the
Company continues to deploy its liquidity in these portfolios (see
"Effects of Interest Rate Changes").
(c)*** The Company uses its liquidity to pay down borrowings. Return on assets is
calculated assuming the use of this liquidity to reduce borrowing costs.
-16-
The overall yield earned on the mortgage investment portfolio averaged 6.68%6.24%
during the secondthird quarter of 2001, compared to 7.06%6.68% during the firstsecond quarter.
As expected, yields on ARM securities peaked during the first quarter of 2001
and then began declining, reflecting the current trend of declining interest
-16-
17
rates that has been evident since the Federal Reserve began lowering short-term
interest rates in January 2001. Yields on ARM securities fluctuate as coupon
interest rates on the underlying mortgage loans reset to reflect current
interest rates and are expected to continue to decline in the coming quarters.
For example, if interest rates stabilize at rates in effect JulyOctober 18, 2001,
average quarterly yields on the Company's current holdings of ARM securitiesmortgage
investments could decline a total of 114121 basis points by the secondthird quarter of
2002. Actual yields on ARM securities will depend on fluctuations in, and market expectations for
fluctuations in, interest rates and levels of mortgage prepayments (see "Effects
of Interest Rate Changes").
Also, asAs expected, principalmortgage prepayment rates on holdings of ARM securities
continued to increaseremained high during the second quarter. The Company currently expects
prepayment ratesthird quarter as
many homeowners took advantage of the lower interest rate environment to
peakrefinance their mortgage loans and Freddie Mac adjusted its remittance cycle
resulting in an additional 15 days of prepayments reported in the third quarter
and begin to decline as moreon Freddie Mac securities. A substantial portion of the mortgage loans
underlying thesethe Company's ARM securities have interest rates that have already
reset to levels at or below most current mortgage rates, reducing or eliminating
the advantage for these homeowners to refinance. Although prepayments are
expected to remain relatively high during at least the fourth quarter,
prepayments should begin to moderate in early 2002 as the remaining loans reset
to lower levels,
eliminating or reducing the advantage for homeowners to refinance into
fixed-rate mortgage loans.levels. Annualized prepayment rates on Ginnie Mae ARM securities
averaged 42.7%40.3% during the secondthird quarter of 2001, significantly
higher thancompared to the 28.2%42.7%
annualized rate during the firstsecond quarter of 2001 and the 16.9% level
experienced during the secondthird quarter of 2000. Annualized prepayment rates on
Fannie Mae and Freddie Mac ARM securities averaged 35.2%38.6% during the secondthird
quarter of 2001 (36.2% excluding the Freddie Mac remittance cycle adjustment),
compared to 24.6%35.2% during the prior quarter and 21.9%22.4% for the same period of
2000. While lower prepayment levels improve mortgage investment yields by
allowing related purchase premiums to be recognized in operating results over a
longer period, higher prepayment levels shorten the period over which the
premiums are amortized thus reducing investment yields. As a result of the increasedcontinued
high prepayments, net amortization of purchase premiums on holdings of ARM
securities increased towas $5.6 million during the third quarter, down slightly from $5.8
million during the second quarter from $4.9 million during the first quarter of 2001. As of JuneSeptember 30, 2001, the net
premium on holdings of ARM securities was 1.15%1.1% of principal, or $44.9$39.7 million.
With its most recent action on June 27,October 2, 2001, the Federal Reserve has reduced
the Federal Funds Rate by a total of 275400 basis points since the beginning of
this year in response to concerns over economic weakness. The 50 basis point
reductions on each of March 20, April 18 and May 15, 2001 and expectations for
an additional rate reduction in Juneyear. This contributed to a 13879 basis point decline in Capstead's average
borrowing rates to 3.64% during the third quarter from 4.43% during the second quarter from 5.81%
during the first
quarter of 2001. The Company's borrowing rates are expected to decline another
6098 basis points in the thirdfourth quarter of 2001 as the full effect of the
second quarterSeptember and October interest rate reductions and the 25 basis point rate
reduction on June 27, 2001 are realized. Any further changes
in Capstead's borrowing rates will depend on future actions by the Federal Reserve to
change short-term interest rates, market expectations of future changes in
short-term interest rates and the extent of any financial market liquidity
concerns (see "Effects of Interest Rate Changes").
CMO COLLATERAL AND INVESTMENTS
Since exiting the residential mortgage loan conduit business in 1995, the
Company has maintained finance subsidiaries with capacity to issue
CMOscollateralized mortgage obligations ("CMOs") and other securitizations backed by
single-family residential mortgage loans
("securitization shelves").loans. From time to time Capstead purchases
mortgage loans from originators or conduits, places these loans into private
mortgage pass-through securities and issues CMOs or other securities backed by
these securities. The Company may or may not retain a significant residual
economic interest in these securitizations. Most of the Company's
securitizations have been afforded financing accounting treatment with the
related collateral recorded as pledged CMO collateral and the outstanding bonds
recorded as CMO liabilities (referred to as "financed
-17-
CMOs"). Other securitizations issued by the Company have been treated as sales
transactions (referred to as "sold CMOs"). During 2001, the Company has not
issued any CMOs. From time to time, the Company exercises its right to redeem
outstanding
CMO bondspreviously issued CMOs (referred to as "clean-up calls") and either sell or hold
the released CMO collateral for investment. During 2001, the Company has exercised
clean-up calls related to 6six financed and three sold CMOs selling $83acquiring $102.3
million of fixed-rate and $15.2 adjustable-rate securities released CMO collateralfrom the
related indentures. The Company sold $97.7 million of the fixed-rate securities
for a gain of $986,000.
-17-
18$1.3 million.
To date, the related credit risk of CMO collateral issued by Capstead has been
borne by AAA-rated private mortgage insurers or by subordinated bonds within the
related CMO series to which the collateral is pledged. As of JuneSeptember 30, 2001,
the Company had only $630,000$543,000 of credit risk held in the form of subordinated
bonds associated with approximately $456$259 million of outstanding securities. 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 $116$106 million of loans outstanding as of
JuneSeptember 30, 2001 from the related securitizations.
CMO collateral and investments, net of related bonds, was $20.6$19.2 million at
JuneSeptember 30, 2001, down from $23.0 million at year-end 2000. Included in this
net investment are $13.5$11.8 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 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 Company's utilization of capital and potential liquidity as of JuneSeptember 30,
2001 were as follows (in thousands):
CAPITAL POTENTIAL
ASSETS BORROWINGS EMPLOYED LIQUIDITY
---------- ---------- ---------- ------------------- ---------
*
Mortgage Investments:
Agency Securities $4,019,183 $3,807,575$3,568,784 $3,361,813 $ 211,608206,971 $ 91,033106,337
Non-agency Securities 76,295 71,294 5,001 1,26384,152 63,838 20,314 16,186
CMBS 72,324 59,855 12,469 (155)71,651 59,317 12,334 (216)
CMO collateral and investments 2,770,882 2,750,284 20,5982,541,003 2,521,847 19,156 --
---------- ---------- ---------- ----------
$6,938,684 $6,689,008 249,676 92,141
========== ========== --------- ---------
$6,265,590 $6,006,815 258,775 122,307
Other assets, net of other liabilities 167,744 115,819*168,000 117,301**
---------- ----------Third quarter common dividend (20,781) (20,781)***
--------- ---------
$ 417,420405,994 $ 207,960
========== ==========218,827
========= =========
* Based on maximum borrowings available under existing uncommitted
repurchase arrangements considering the fair value of related collateral
as of JuneSeptember 30, 2001 (see "Liquidity and Capital Resources").
** Represents cash and cash equivalents.
*** Declared October 18, 2001 and payable November 20, 2001 to stockholders of
record November 5, 2001.
The Company finances its mortgage investments with investment banking firms
under repurchase arrangements (see "Liquidity and Capital Resources"). CMO
collateral and investments are generally pledged to secure CMO bonds. Liquidity
is affected by, among other things, changes in market value of assets pledged
under repurchase arrangements, principal prepayments and general conditions in
the mortgage finance industry. The $201.2 million special dividend payment on
June 29, 2001 reduced the Company's liquidity below year-end 2000 levels and
increased the level of financial leverage currently employed by the Company.
Future levels of financial leverage will be dependent upon many factors,
including the size and composition of the Company's investment portfolios (see
"Liquidity and Capital Resources" and "Effects of Interest Rate Changes").
-18-
TAX CONSIDERATIONS OF 2001 COMMON DIVIDENDS, INCLUDING THE SPECIAL COMMON
DIVIDEND
Each common dividend distribution paid duringapplicable to the 2001 tax year is expected to
be made up of taxable income and return of capital. The taxable income component
will be calculated on the ratio of the Company's taxable income for the year to
total distributions made for the year, applied to each common dividend
distribution, including the fourth quarter regular dividend expected to be
declared in early December 2001 and paid January 31, 2002, and the $14.60
special common dividend. The Company estimates that the per share dollar amount
of the return of capital component of the 2001 common dividend, in total, will
approximate the amount of
-18-
19 the special common dividend. Thus, common stockholders
receiving all regular quarterly dividends for 2001, as well as the special
common dividend, can expect to receive return of capital per common share
approximating $14.60. Final dividend characterization will not be known until
the close of the Company's tax year. Dividend characterization information will
be available by the end of January 2002.
StockholdersCommon stockholders should reduce the tax cost basis of their shares by the
amount of return of capital distributions received in 2001 and in prior years,
if applicable. Return of capital distributions received in excess of tax cost
basis should be reported as capital gain. Also, special rules apply for
stockholders who sold shares between the June 13 special dividend record date
and the July 2, 2001 ex-dividend date. Due to the complex nature of the
applicable tax rules, it is recommended that stockholders consult their tax
advisors to ensure proper tax treatment of common dividends received from the Company for 2001.received.
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):
QUARTER ENDED SIXNINE MONTHS ENDED
JUNESEPTEMBER 30 JUNESEPTEMBER 30
------------------------ ------------------------------------------- --------------------
2001 2000 2001 2000
-------- ------- -------- --------
--------Mortgage Investments:
Agency Securities $ 25,82825,722 $ 8,2177,619 $ 45,76871,490 $ 19,13726,756
Non-agency Securities 1,960 1,792 3,761 3,182753 1,800 4,514 4,982
CMBS 520 587 1,073 1,129486 619 1,559 1,748
CMO collateral and investments (130) (570) (202) (807)(182) (375) (384) (1,182)
-------- --------------- -------- --------
Net margin on mortgage assets 28,178 10,026 50,400 22,64126,779 9,663 77,179 32,304
Other revenue (expense):
Gain (loss) on sale of mortgage assets 986 (70,920) 6,849 (70,920)292 747 7,141 (70,173)
Impairment on mortgage assets -- (19,088)-- -- (19,088)
Severance charges -- (3,607)-- -- (3,607)
CMO administration and other 1,612 893 2,331 1,677683 781 3,014 2,458
Other operating expense (3,007) (1,556) (7,163) (3,285)(2,678) (1,424) (9,840) (4,709)
-------- --------------- -------- --------
Net income (loss) $ 27,769 $(84,252)25,076 $ 52,417 $(72,582)9,767 $ 77,494 $(62,815)
======== =============== ======== ========
Net income (loss) per common share:
Basic $ 1.771.45 $ (7.97)0.30 $ 3.274.71 $ (7.21)(7.01)
Diluted 1.63 (7.97) 3.01 (7.21)1.27 0.30 4.22 (7.01)
Operating * 1.40 0.23 3.92 1.01
* Operating income per common share is calculated excluding gain (loss) on
sale of mortgage assets, impairment and severance charges incurred in June
2000 and the dilutive effects of the Series B preferred shares. See NOTE 4
to the accompanying financial statements for discussion regarding the
impact on the calculation of diluted net income per share of adjustments to
preferred share conversion rates resulting from the June 29, 2001 special
common dividend payment.
-19-
The earning capacity of the Company'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.
Net margins on mortgage assets and financing spreads (the difference between
yields earned on mortgage investments and rates charged on related borrowings)
have benefited during 2001 from actions taken by the Federal Reserve since the
beginning of this year to aggressively lower short-term interest rates, which
have resulted in lower interest rates on the Company's borrowings. In addition,
yields on ARM securities steadily increased during 2000 and into early 2001 as
coupon interest rates on the underlying mortgage loans reset higher reflecting
the relatively high interest rate environment experienced during 2000. Yields
were also impacted by the portfolio restructuring that commenced during the
second quarter of last year and resulted in the sale or designation for sale of
nearly all fixed-rate and medium-term securities previously held in the
portfolio and the acquisition during the latter part of 2000 of additional ARM
securities with the proceeds from these sales.
-19-
20
Although the Company anticipates continued improvement in financing spreads
during the thirdfourth quarter of 2001, lower interest rates have also spurred higher
levels of mortgage prepayments, reducing the overall size of the Company's
mortgage investment portfolios andportfolios. Lower interest rates have also negatively
impacted yields on ARM Securities have begun to reset
lower.securities which began resetting lower after peaking in
early 2001. In addition, while having a positive impact on returns on common
equity under current market conditions, the payment of the special dividend on
June 29, 2001 has increased the level of financial leverage employed by the
Company to support its current investment portfolios going forward.portfolios. See "Financial Condition -
Mortgage Investments" for further discussion of the effects on ARM yields and
borrowing rates of recent actions taken by the Federal Reserve to lower
short-term interest rates and "Utilization of Capital and Potential Liquidity"
for further discussion of financial leverage.
Agency Securities contributed more to operating results during the quarter and
sixnine months ended JuneSeptember 30, 2001 than in the same periodperiods of 2000 primarily
because of improvements in financing spreads as discussed above, despite the
smaller average size of the portfolio in 2001. Yields for this portfolio
averaged 6.64%6.22% and 6.84%6.66% during the quarter and sixnine months ended JuneSeptember 30,
2001, respectively, compared to 6.44%6.81% and 6.27%6.44% during the same periods in 2000,
while average borrowing rates were 4.43%3.63% and 5.14%4.69%, respectively, compared to
6.24%6.56% and 6.04%6.21% during the same periods in 2000. The average outstanding Agency
Securities portfolio was $4.3$3.8 billion and $4.5$4.3 billion during the quarter and
sixnine months ended JuneSeptember 30, 2001, respectively, compared to $4.9$4.8 billion and
$5.1$5.0 billion during the same periods in 2000.
Non-agency Securities contributed moreless to operating results during the quarter
and sixnine months ended JuneSeptember 30, 2001 despiteprimarily as a result of a lower
average outstanding portfolio
because of lower borrowing costs.portfolio. The average outstanding portfolio was $101$77 million
and $96$90 million, respectively, during the quarter and sixnine months ended JuneSeptember 30, 2001,
respectively, compared to $183$164 million and $173$170 million during the same periods
in 2000. During the first six months of 2001, this portfolio was funded almost
entirely with equity, while inborrowings averaged $68 million during the corresponding periodsthird
quarter of 2000, it was
financed with average borrowings of $111 million and $115 million, respectively.2001. The Company anticipates borrowing against this portfolio for
the remainder of 2001. During the quarter and nine months ended September 30,
2000, average borrowings were $85 million and $105 million, respectively.
Average yields for this portfolio (calculated including mortgage insurance
costs) were 7.94%7.18% and 8.08%7.82% during the quarter and sixnine months ended JuneSeptember
30, 2001, respectively, compared to 7.88%8.00% and 7.89%7.93% during the same periods in
2000.
The Company made its first acquisitions of credit-sensitive CMBS in December
1999. Since early 2000, the Company has not made any additions to this
portfolio, which currently consists of $72$71.7 million of adjustable-rate CMBS
financed by longer-term repurchase arrangements. These investments yielded 7.09%6.19%
and 7.73%7.22% during the quarter and sixnine months ended JuneSeptember 30, 2001,
respectively, while average borrowing rates were 5.05%4.24% and 5.70%5.22%, respectively.
-20-
CMO collateral and investments results continue to diminish as the CMO
securitizations that Capstead has retained interests in continue to runoff or
are redeemed pursuant to clean-up calls (see "Financial Condition - CMO
Collateral and Investments"). Without 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 significant positive return on capital
employed in future periods.
Gain on sale of mortgage assets reflects the second and third quarter 2001 salesales
of $83$98 million of fixed-rate released CMO collateral and the first quarter 2001
sale of $451 million of medium-term Agency Securities.
Although
CMO administration revenue was lower this year primarily because a declining
portfolio of CMOs for which Capstead provides administrative services,
otherservices. Other
revenue increased during the second quarter of 2001 as the Company
invested a larger than normal amount of itsbenefited from investing excess liquidity in short-term investments. With the dramatic decline in interest rates this year, the Company
has temporarily enjoyed ainvestments to
take advantage of positive spreadspreads between interest rates on overnight
investments and its short-term borrowing rates.
-20-
21
Other operating expenses include higher accruals for incentive compensation
because of the expectation that the Company's performance in 2001 will exceed
predetermined benchmarks established by the Compensation Committee of the Board
of Directors.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds include borrowings under repurchase
arrangements, monthly principal and interest payments on mortgage investments,
excess cash flows on CMO collateral and investments and proceeds from sales of
mortgage assets (see "Financial Condition - Utilization of Capital and Potential
Liquidity"). The Company currently believes that these funds are sufficient for
the acquisition of real estate-related investments, repayments on borrowings,
and the payment of cash dividends as required for Capstead's continued
qualification as a REIT. 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, market liquidity 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 consistent
net interest spreads on these investments. Should Capstead make significant
additional investments in credit-sensitive mortgage assets, 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").
-21-
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 willcould have on
future earnings. All mortgage assets and Derivatives held, if any, are included
in this analysis. The sensitivity of Other revenue and expense to changes in
interest rates is included as well. The model incorporates management
assumptions regarding the level of prepayments on mortgage assets for a given
interest rate change using market-based estimates of prepayment speeds. These
assumptions are developed through a combination of historical analysis and
future expected pricing behavior.
-21-
22
As of JuneSeptember 30, 2001, Capstead had the following estimated earnings
sensitivity profile (dollars in thousands):
10-YEAR
30-DAY U.S.
LIBOR TREASURY
RATE RATE IMMEDIATE CHANGE IN:*
------ -------- --------------------------------------------------------------- ---------- -------------------------------------------------------
30-day LIBOR rate Down 1.00% Down 1.00% Flat Up 1.00%
10-year U.S. Treasury rate Down 1.00% Flat Up 1.00% Up 1.00%
Projected 12-month
earnings change:**
JuneSeptember 30, 2001 3.86% 5.41% $ 20,629 $ 25,248 $ 3,815 $(18,835)2.63% 4.59% $16,698 $22,573 $3,705 $(18,445)
December 31, 2000 6.56 5.12 18,344 23,447 4,145 (22,665)
* Sensitivity of earnings to changes in interest rates is determined
relative to the actual rates at the applicable date.
** Note that the projected 12-month earnings change is predicated on
acquisitions of similar assets sufficient to replace runoff. There can be
no guaranteeassurance that suitable investments will be available for purchase at
attractive prices or if investments made will behave in the same fashion
as assets currently held.
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.
Earnings currently depend primarily on the difference between the interest
received on mortgage investments and the interest paid on related borrowings,
which are generally based on 30-day LIBOR, an index that reflects prevailing
short-term interest rates. The resulting spread may be reduced or even be
negative in a rising short-term interest rate environment. Because the mortgage
investment portfolio currently consists primarily of ARM mortgage securities, the risk of
rising short-term interest rates is offset to some extent by increases in the
rates of interest earned on the underlying ARM loans, a portion of which reset
each month, based on underlying indices (generally 1-year CMT rates). Since only
a portion of the ARM loans underlying the Company's securities reset each month,
and the terms of an ARM loan 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, and as is currently being experienced
in 2001, declines in these indices during periods of falling short-term interest
rates will negatively effect yields on ARM securities as the underlying ARM
loans reset at lower rates. If declines
-22-
in these indices exceed declines in the Company's borrowing rates, earnings may
be adversely affected. The Company may invest in Derivatives from time to time
with the goal of achieving more stable financing spreads on a portion of its
mortgage investments portfolio. The Company did not own any Derivatives for this
purpose as of the date of this filing.
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. As seen in 1998, and to some extent in
2001, 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. Further, to the extent
the proceeds of prepayments on mortgage investments are not
-22-
23 reinvested or cannot
be reinvested at a rate of return at least equal to the rate previously earned
on such investments, earnings may be adversely affected. There can be no
assurance that suitable investments at attractive pricing will be available in a
timely fashion to replace runoff as it occurs or that the current composition of
investments (consisting primarily of ARM Agency Securities) will be maintained.
A change in interest rates also impacts results recognized in earnings from CMO
collateral and investments, which currently consist primarily of fixed-rate CMO
residuals (see "Financial Condition"). As seen in 1998, if mortgage interest
rates fall, prepayments on the underlying mortgage loans generally will be
higher, accelerating the amortization of collateral premiums and bond discounts.
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 positive net cash flows and can
amortize remaining collateral premiums and bond discounts.
The Company periodically sells mortgage assets, which may increase income
volatility because of the recognition of transactional gains or losses. Such
sales may become attractive or prudent as values of mortgage assets fluctuate
with changes in interest rates and market liquidity. At other times, such as in
the second quarter of 2000, asset sales may become prudent to shift the
Company's investment focus. Because Capstead currently has significant capital
loss carryforwards for tax purposes, gains on the sale of mortgage assets may
not be distributed to stockholders as dividends.
During periods of rising interest rates or falling market liquidity, mortgage
asset values can decline leading to increased margin calls, reducing the
Company's liquidity. A margin call means that a lender requires a borrower to
pledge additional collateral to re-establish the agreed-upon ratio of the value
of the collateral to the amount of the borrowing. If the Company is unable or
unwilling to pledge additional collateral, lenders can liquidate the collateral
under adverse market conditions, likely resulting in losses.
RISKS ASSOCIATED WITH CREDIT-SENSITIVE INVESTMENTS
Commercial mortgage assets may be viewed as exposing an investor to greater risk
of loss than residential mortgage assets since such assets are typically secured
by larger loans to fewer obligors than residential mortgage assets. Commercial
property values and related net operating income are often 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.
-23-
Additionally, commercial properties may not be readily 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 often
requires substantial capital expenditures, the capital for which may or may not
be available.
The availability of credit for commercial mortgage loans may be 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.
-23-
24
Credit-sensitive residential mortgages differ from commercial mortgages 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 credit-sensitive residential mortgage-backed 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 a higher risk of default than loans qualifying for such programs.
As with commercial mortgages, 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 mortgages 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 lower credit
ratings, higher yields 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 even lower
credit ratings and higher yields 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 commercial and residential mortgage assets 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 assets, sufficient capital may not be available to support the continued
ownership of such investments, requiring these assets 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 Capstead's investments and unforeseen
factors.
-24-
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."
-24-
25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The following stockholder meetings were held in 2001: Annual Meeting held
April 19 and a Special Meeting held June 15. The following items were voted
on at the respective meetings:
WITHHELD/
ANNUAL MEETING FOR ABSTENTIONS
---------- -----------
o The following Directors were elected to Capstead's Board of
Directors (constituting the entire Board of Directors):
Wesley R. Edens 13,193,448 169,709
Robert I. Kauffman 13,194,810 168,346
Paul M. Low 13,182,710 180,446
Ronn K. Lytle 13,164,480 198,677
Michael G. O'Neil 13,191,508 171,649
Howard Rubin 13,197,019 166,138
Mark S. Whiting 13,197,703 165,453
FOR AGAINST ABSTAIN
---------- --------- --------
o Approval of an amendment to the 1994 Flexible Long-Term Incentive
Plan to increase the number of common shares that may be granted and
expand eligibility 11,724,762 1,522,823 115,571
o Reapproval of the 1996 Incentive Bonus Plan, as amended,
to add two performance measures 12,694,387 542,938 125,832
o Other matters (no other matters).
SPECIAL MEETING
o Amend Capstead's Charter to effect a 1-for-2 reverse
common stock split 12,091,217 1,064,455 47,592
o Other matters (no other matters).
-25-
26
PART II. -- OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
(a) Adjustments to Preferred Share Conversion Rates: As a consequence of the
special common dividend and reverse stock split, the conversion rates of
the Series A and B preferred shares were adjusted concurrently in
accordance with the terms of the governing Articles Supplementary, as
follows:
PREFERRED SHARES PRIOR RATES ADJUSTED RATES
---------------- ----------- --------------
Series A 1.1049 0.9657
Series B 0.3844 0.3559
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The following Exhibits are presented herewith:
Exhibit 10.29 - 1996 Incentive Bonus Plan, as amended.
Exhibit 12 - Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends.
(b) Reports on Form 8-K: Current report on Form 8-K dated July 2, 2001 to file
the following:
Exhibit 5.0 - Selected Financial Data.None
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: August 10,November 5, 2001 By: /s/ ANDREW F. JACOBS
-------------------------------------------------------------------
Andrew F. Jacobs
Executive Vice President - Finance
Date: August 10,November 5, 2001 By: /s/ PHILLIP A. REINSCH
-------------------------------------------------------------------
Phillip A. Reinsch
Senior Vice President - Control
-26--25-
27
EXHIBIT INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- --------------- -----------
10.29 - 1996 Incentive Bonus Plan, as amended.Exhibit 12 - Computation of Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividends.