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Capstead Mortgage Corporation Announces First Quarter 2019 Results

DALLAS–(BUSINESS WIRE)–Capstead Mortgage Corporation (“Capstead” or the “Company”) (NYSE: CMO)
today announced financial results for the quarter ended March 31, 2019,
and introduced core earnings, a non-GAAP financial measure.

First Quarter 2019 Summary

  • Generated an annualized economic return of 5.1%, consisting of a
    $0.04 increase in book value to $9.43 per common share and an $0.08
    per common share first quarter dividend
  • Recognized a GAAP net loss of $7.7 million or $(0.15) per diluted
    common share
  • Generated core earnings of $15.5 million or $0.12 per diluted
    common share, an increase of $0.07 per common share over the prior
    quarter
  • Increased agency-guaranteed residential adjustable-rate mortgage
    (ARM) portfolio to $12.23 billion and leverage to 9.65 times long-term
    investment capital

First Quarter Earnings and Related Discussion

Capstead reported a GAAP net loss of $7.7 million or $(0.15) per diluted
common share for the quarter ended March 31, 2019. On March 1, 2019 the
Company discontinued its use of hedge accounting on its interest rate
swaps related to secured borrowings and introduced a core earnings
metric. Consequently, GAAP net loss for the quarter included a loss in
fair value of these derivatives of $26.2 million and amortization of the
net unrealized gains of $3.0 million from the date of de-designation.
The Company reported core earnings of $15.5 million or $0.12 per diluted
common share for the quarter ended March 31, 2019. This compares to net
income and core earnings of $9.0 million or $0.05 per diluted common
share for the quarter ended December 31, 2018. As described further in
the “Non-GAAP Financial Measures” section of this release, core earnings
and core earnings per common share exclude the above-mentioned GAAP
adjustments related to no longer using hedge accounting for GAAP
purposes.

Portfolio yields averaged 2.75% during the first quarter of 2019, an
increase of 41 basis points from the 2.34% reported for the fourth
quarter. Cash yields (yields on the portfolio before investment premium
amortization) continued benefiting from mortgage loans underlying the
portfolio resetting to higher rates based on higher prevailing six- and
12-month interest rate indices and higher coupon interest rates on
recent acquisitions. Yields also benefited from lower investment premium
amortization as a result of declining mortgage prepayment rates, lower
pricing levels on recent acquisitions and changes in prepayment
estimates. Mortgage prepayment rates averaged an annualized constant
prepayment rate, or CPR, of 20.62%, a decrease of 1.75% CPR from an
average of 22.37% CPR the previous quarter.

Capstead’s portfolio of residential mortgage investments increased $263
million during the first quarter of 2019 to $12.23 billion, with
acquisitions exceeding portfolio runoff by $214 million (principal
amount) with the remaining increase primarily attributable to increases
in unrealized gains on the portfolio.

Rates on Capstead’s $11.22 billion in secured borrowings, after
adjusting for hedging activities, averaged 16 basis points higher at
2.23% during the first quarter of 2019, compared to 2.07% for the prior
quarter. This increase is largely attributable to the funding market’s
response to a 25 basis point increase in the Federal Funds Rate in
December 2018, partially mitigated by the Company’s hedging activities.
During the first quarter the Company added $2.60 billion in three-year
swap agreements at attractive rates relative to short-term borrowings
while $950 million of swaps with relatively lower fixed rates matured.
The Company typically uses two- and three-year term pay fixed, receive
variable swaps with variable rate receipts based on three-month LIBOR to
help mitigate exposure to rising short-term interest rates. At
quarter-end the Company held $8.20 billion notional amount of interest
rate swaps related to secured borrowings with contract expirations
occurring at various dates through the first quarter of 2022 and a
weighted average expiration of 19 months.

Portfolio leverage (secured borrowings divided by long-term investment
capital) increased to 9.65 to one at March 31, 2019 from 9.49 to one at
December 31, 2018, reflecting portfolio growth.

Capstead operates a highly efficient investment platform, particularly
compared to other mortgage REITs and has a competitive cost structure
relative to a wide variety of high yielding investment vehicles. The
Company currently anticipates operating costs expressed as an annualized
percentage of long-term investment capital will be approximately 1.3%
for 2019. Expressed as an annualized percentage of total assets,
operating costs are expected to be approximately 0.12% for 2019.

Book Value per Common Share

Book value per share as of March 31, 2019 was $9.43, an increase of
$0.04 or 0.4% over December 31, 2018 book value of $9.39. Capstead’s
investment strategy attempts to mitigate risks to book value by focusing
on investments in agency-guaranteed residential mortgage pass-through
securities, which are considered to have little, if any, credit risk and
are collateralized by ARM loans with interest rates that reset
periodically to more current levels. Because of these characteristics,
the fair value of the Company’s portfolio is expected to be less
vulnerable to significant pricing declines caused by credit concerns or
rising interest rates compared to leveraged portfolios containing a
significant amount of non-agency-guaranteed securities or
agency-guaranteed securities backed by longer-duration ARM or fixed-rate
loans. Fair value is impacted by market conditions including changes in
interest rates, the availability of financing at reasonable rates and
leverage levels, among other factors.

Management Remarks

Commenting on current operating and market conditions, Phillip A.
Reinsch, President and Chief Executive Officer, said, “Our first quarter
2019 earnings benefited from higher cash yields, lower investment
premium amortization and favorable terms on new swaps entered into
during the quarter, which together with higher portfolio balances more
than offset the effects of higher borrowing costs resulting from the
December 2018 federal funds rate increase.

“Cash yields should continue increasing in the coming quarters through
coupon resets and acquisitions, albeit at a slower pace given that the
underlying indices have declined since year-end. With the Federal
Reserve indicating it is unlikely to increase the federal funds rate
this year, we anticipate more stable borrowing costs in the coming
quarters affording us the opportunity to continue to recover financing
spreads diminished by previous increases in borrowing rates. While our
board authorized an increase to our common stock repurchase program in
February, we did not repurchase any shares this quarter due to higher
trading prices of our common stock and opportunities to grow our
portfolio of agency-guaranteed ARM securities at attractive levels.

“Discontinuing hedge accounting for our interest rate swaps related to
secured borrowings has improved our flexibility in managing our balance
sheet and eliminated ongoing administrative costs associated with using
hedge accounting. In connection with this change, we also adopted a core
earnings presentation in order to depict for our investors our operating
results in a manner consistent with our previous earnings presentations
and how we manage the business.

“For nearly 20 years, Capstead has operated as a cost-effective,
internally managed REIT that invests in a leveraged portfolio of short
duration agency-guaranteed residential ARM securities with the goal of
generating attractive risk-adjusted returns over the long-term. For
investors seeking risk-adjusted levered returns with a comparably higher
degree of safety from interest rate and credit risk, we believe Capstead
represents a reasonably compelling opportunity that is difficult to find
elsewhere in the markets.”

Non-GAAP Financial Measures

Management believes the presentation of core earnings and core earnings
per common share, non-GAAP financial measures, when analyzed in
conjunction with the Company’s GAAP operating results, allows investors
to more effectively evaluate and compare the performance of the Company
to that of its peers. Historically, the Company designated its interest
rate swaps related to secured borrowings as hedges for accounting
purposes, whereby changes in the swaps’ fair values were recorded in Accumulated
other comprehensive income
. The Company discontinued hedge
accounting on March 1, 2019 for these swaps and, for GAAP purposes,
related changes in the fair value are recorded in the Company’s
consolidated statement of operations beginning on that date. Also, for
GAAP purposes, related net unrealized gains recorded in Accumulated
other comprehensive income
through February 28, 2019 are being
recognized as a component of interest expense in the Company’s
consolidated statement of operations over the remaining life of these
swaps. Core earnings and core earnings per common share exclude these
GAAP adjustments.

Management believes that presenting financing spreads on residential
mortgage investments, a non-GAAP financial measure, provides important
information for evaluating the performance of the Company’s portfolio as
opposed to total financing spreads because the non-GAAP measure speaks
specifically to the performance of the Company’s investment portfolio.

Earnings Conference Call Details

An earnings conference call and live audio webcast will be hosted
Thursday, April 25, 2019 at 9:00 a.m. ET. The conference call may be
accessed by dialing toll free (877) 505-6547 in the U.S., (855) 669-9657
for Canada, or (412) 902-6660 for international callers. A live webcast
of the conference call can be accessed via the investor relations
section of the Company’s website at www.capstead.com
and an archive of the webcast will be available up to the date of our
next earnings press release. An audio replay can be accessed one hour
after the end of the conference call, also up to the date of our next
earnings press release, by dialing toll free (877) 344-7529 in the U.S.,
(855) 669-9658 for Canada, or (412) 317-0088 for international callers
and entering conference number 10130702.

About Capstead

Capstead is a self-managed real estate investment trust, or REIT, for
federal income tax purposes. The Company earns income from investing in
a leveraged portfolio of residential adjustable-rate mortgage
pass-through securities, referred to as ARM securities, issued and
guaranteed by government-sponsored enterprises, either Fannie Mae or
Freddie Mac, or by an agency of the federal government, Ginnie Mae.

Statement Concerning Forward-looking Statements

This document contains “forward-looking statements” within the meaning
of the Private Securities Litigation Reform Act of 1995. Forward-looking
statements include, without limitation, any statement that may predict,
forecast, indicate or imply future results, performance or achievements,
and may contain the words “believe,” “anticipate,” “expect,” “estimate,”
“intend,” “will be,” “will likely continue,” “will likely result,” or
words or phrases of similar meaning. Actual results could differ
materially from those projected in these forward-looking statements due
to a variety of factors, without limitation, fluctuations in interest
rates, the availability of suitable qualifying investments, changes in
mortgage prepayments, the availability and terms of financing, changes
in market conditions as a result of federal corporate and individual tax
reform, changes in legislation or regulation affecting the mortgage and
banking industries or Fannie Mae, Freddie Mac or Ginnie Mae securities,
the availability of new investment capital, the liquidity of secondary
markets and credit markets, and other changes in general economic
conditions. These and other applicable uncertainties, factors and risks
are described more fully in the Company’s filings with the U.S.
Securities and Exchange Commission. Forward-looking statements speak
only as of the date the statement is made and the Company undertakes no
obligation to update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise. Accordingly,
readers of this document are cautioned not to place undue reliance on
any forward-looking statements included herein.

   
 
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEETS

(in thousands, except ratios, pledged and per share amounts)

 
      March 31, 2019     December 31, 2018
(unaudited)
Assets

Residential mortgage investments ($11.82 and $11.57 billion
pledged at March 31, 2019 and December 31, 2018, respectively)

$ 12,228,422 $ 11,965,381
Cash collateral receivable from interest rate swap counterparties 58,191 31,797
Interest rate swap agreements at fair value 7,037
Cash and cash equivalents 32,433 60,289
Receivables and other assets   115,691     129,058  
$ 12,441,774   $ 12,186,525  
Liabilities
Secured borrowings $ 11,222,451 $ 10,979,362
Interest rate swap agreements at fair value 21,903 17,834
Unsecured borrowings 98,317 98,292
Common stock dividend payable 7,110 7,132
Accounts payable and accrued expenses   27,115     24,842  
  11,376,896     11,127,462  
Stockholders’ equity

Preferred stock – $0.10 par value; 100,000 shares authorized:
7.50% Cumulative Redeemable Preferred Stock, Series E, 10,329
shares issued and outstanding ($258,226 aggregate liquidation
preference) at March 31, 2019 and December 31, 2018

250,946 250,946

Common stock – $0.01 par value; 250,000 shares authorized: 85,580
and 85,277 shares issued and outstanding at March 31, 2019 and
December 31, 2018, respectively

856 853
Paid-in capital 1,175,878 1,174,880
Accumulated deficit (366,110 ) (346,570 )
Accumulated other comprehensive income   3,308     (21,046 )
  1,064,878     1,059,063  
$ 12,441,774   $ 12,186,525  
 
Long-term investment capital (consists of stockholders’
equity and unsecured borrowings) (unaudited)
$ 1,163,195 $ 1,157,355
Portfolio leverage (secured borrowings divided by
long-term investment capital) (unaudited)
9.65:1 9.49:1
Book value per common share (based on common shares
outstanding and calculated assuming liquidation preferences for
preferred stock) (unaudited)
$ 9.43 $ 9.39
 
   
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

Quarter Ended
March 31

2019     2018
Interest income:
Residential mortgage investments $ 83,807 $ 69,138
Other   422     408  
  84,229     69,546  
Interest expense:
Secured borrowings (63,779 ) (45,021 )
Unsecured borrowings   (1,891 )   (1,891 )
  (65,670 )   (46,912 )
  18,559     22,634  
Other (expense) income:
Loss on derivative instruments (net) (21,657 )
Compensation-related expense (3,609 ) (2,048 )
Other general and administrative expense (1,128 ) (1,237 )
Miscellaneous other revenue   89     71  
  (26,305 )   (3,214 )
Net (loss) income (7,746 ) 19,420
Less preferred stock dividends   (4,842 )   (4,842 )
Net (loss) income to common stockholders $ (12,588 ) $ 14,578  
 
Net (loss) income per common share:
Basic and diluted $ (0.15 ) $ 0.16
 
Weighted average common shares outstanding:
Basic 84,894 93,425
Diluted 84,894 93,506
 
Cash dividends declared per share:
Common $ 0.08 $ 0.16
Series E preferred 0.47 0.47
 
       
CAPSTEAD MORTGAGE CORPORATION
QUARTERLY STATEMENTS OF OPERATIONS AND SELECT OPERATING STATISTICS

(unaudited, in thousands, except per share amounts,
percentages annualized)

 
2019 2018
Q1 Q4     Q3     Q2     Q1
Quarterly Statements of Operations:
Interest income:
Residential mortgage investments $ 83,807 $ 72,902 $ 67,649 $ 65,202 $ 69,138
Other   422     626     350     305     408  
  84,229     73,528     67,999     65,507     69,546  
Interest expense:
Secured borrowings (63,779 ) (59,321 ) (54,393 ) (48,241 ) (45,021 )
Unsecured borrowings   (1,891 )   (1,910 )   (1,910 )   (1,900 )   (1,891 )
  (65,670 )   (61,231 )   (56,303 )   (50,141 )   (46,912 )
  18,559     12,297     11,696     15,366     22,634  
Other (expense) income:
Loss on derivative instruments (net) (21,657 )
Compensation-related expense (3,609 ) (2,238 ) (1,913 ) (1,560 ) (2,048 )
Other general and administrative expense (1,128 ) (1,207 ) (1,184 ) (899 ) (1,237 )
Miscellaneous other revenue   89     132     81     81     71  
  (26,305 )   (3,313 )   (3,016 )   (2,378 )   (3,214 )
Net (loss) income $ (7,746 ) $ 8,984   $ 8,680   $ 12,988   $ 19,420  
Net (loss) income per diluted common share $ (0.15 ) $ 0.05 $ 0.04 $ 0.09 $ 0.16
Average diluted common shares outstanding 84,894 88,006 91,346 92,121 93,506
 
Select Operating Statistics:
Average portfolio outstanding (cost basis) $ 12,169,106 $ 12,442,410 $ 13,026,636 $ 13,025,353 $ 13,303,044
Average secured borrowings 11,156,608 11,439,646 11,957,518 11,914,562 12,235,554

Average long-term investment capital (“LTIC”)

1,161,815 1,188,553 1,258,367 1,280,231 1,314,537
Core net income 15,471 8,984 8,680 12,988 19,420
Core net income per diluted common share 0.12 0.05 0.05 0.09 0.16
Constant prepayment rate (“CPR”) 20.62 % 22.37 % 25.71 % 23.82 % 19.64 %
Total financing spreads 0.42 0.22 0.21 0.33 0.55

Yields on residential mortgage investments

2.75 2.34 2.08 2.00 2.08
Secured borrowing rates (a) 2.23 2.07 1.82 1.62 1.47

Financing spreads on residential mortgage investments

0.52 0.27 0.26 0.38 0.61
Operating costs as a percentage of LTIC (b) 1.32 1.15 0.98 0.77 1.01
Return on common equity capital 5.33 1.96 1.69 3.51 6.12
 

(a)

 

Secured borrowing rates exclude the effects of amortization of
the net unrealized gains in Accumulated other comprehensive income
on de-designated swaps and include net interest cash flows on
de-designated hedges to better compare the components of financing
spreads on residential mortgage investments with prior periods.
See “Reconciliation of GAAP Measures to Non-GAAP Measures” for
details on the impact of cash flow hedge de-designations.

 

(b)

Excludes the effects of first quarter 2019 adjustments to 2018
incentive compensation accruals totaling $(949,000) due to the
Company’s outperformance relative to its peers.

 
 

CAPSTEAD MORTGAGE CORPORATION

RECONCILIATION OF GAAP MEASURES TO NON-GAAP MEASURES

(annualized, unaudited)

 

The following reconciles GAAP net (loss) income and net (loss) income
per common share to core earnings and core earnings per common share:

    2019     2018
Q1 Q4     Q3     Q2     Q1
Amount   Per Share Amount   Per Share Amount   Per Share Amount   Per Share Amount   Per Share
Net (loss) income $ (7,746 ) $ (0.15 ) $ 8,984 $ 0.05 $ 8,960 $ 0.04 $ 12,988 $ 0.09 $ 19,420 $ 0.16

Unrealized loss on derivative instruments

26,237 0.31

Amortization of unrealized gains, net of unrealized losses, on
de-designated financial derivatives (a)

  (3,020 )   (0.04 )                
Core earnings $ 15,471   $ 0.12   $ 8,984 $ 0.05 $ 8,960 $ 0.04 $ 12,988 $ 0.09 $ 19,420 $ 0.16
 

(a)

 

Consists of unrealized gains and losses included in accumulated
other comprehensive income on two- and three-year swaps previously
designated as cash flow hedges of secured borrowings that are
being amortized over these instruments’ contractual terms as a
component of interest expense for GAAP purposes.

 
 

The following reconciles total financing spreads to financing spreads on
residential mortgage investments:

    2019     2018
Q1 Q4     Q3     Q2     Q1
Total financing spreads 0.42 % 0.22 % 0.21 % 0.33 % 0.55 %
Impact of yields on other interest-earning assets* 0.01

Impact of borrowing rates on other interest-paying liabilities*

0.05 0.05 0.05 0.05 0.05

Impact of amortization of unrealized gain in Accumulated other
comprehensive income

(0.11 )

Impact of realized gain on de-designated derivative instruments

0.16

Financing spreads on residential mortgage investments

0.52 0.27 0.26 0.38 0.61
 

*

   

Other interest-earning assets consist of overnight investments
and cash collateral receivable from interest rate swap
counterparties. Other interest-paying liabilities consist of
unsecured borrowings and, at times, cash collateral payable to
interest rate swap counterparties.

 
       
CAPSTEAD MORTGAGE CORPORATION
FAIR VALUE AND SWAP MATURITY DISCLOSURES

(dollars in thousands, unaudited)

 
March 31, 2019

December 31,
2018

Unpaid

Principal

Balance

    Investment Premiums     Basis or

Notional

Amount

    Fair

Value

    Unrealized Gains

(Losses)

Unrealized Gains

(Losses)

Residential mortgage investments classified as
available-for-sale:
(a)

Fannie Mae/Freddie Mac securities:
Current-reset ARMs $ 4,748,713 $ 158,836 $ 4,907,549 $ 4,954,464 $ 46,915 $ 48,091
Longer-to-reset ARMs 4,096,087 101,671 4,197,758 4,164,182 (33,576 ) (66,326 )
Ginnie Mae securities:
Current-reset ARMs 1,150,026 38,289 1,188,315 1,193,211 4,896 4,433
Longer-to-reset ARMs   1,876,059   40,360   1,916,419   1,914,414     (2,005 )   (13,444 )
$ 11,870,885 $ 339,156 $ 12,210,041 $ 12,226,271   $ 16,230   $ (27,246 )
Interest rate swap agreements: (b)
Secured borrowings-related $ 8,200,000 $ (14,237 ) $ 8,981 $ 24,033
Unsecured borrowings-related 100,000 (21,903 ) (21,903 ) (17,834 )
 

(a)

 

Unrealized gains and losses on residential mortgage securities
classified as available-for-sale are recorded as a component of
Accumulated other comprehensive income in Stockholders’ equity.
Residential mortgage securities classified as held-to-maturity
with a cost basis of $1.1 million and unsecuritized investments in
residential mortgage loans with a cost basis of $1.1 million are
not subject to fair value accounting and therefore have been
excluded from this analysis. Capstead segregates its residential
ARM securities based on the average length of time until the loans
underlying each security reset to more current rates.

 

(b)

Secured borrowings-related swap positions were de-designated as
cash flow hedges for accounting purposes on March 1, 2019 and
unrealized gains held in Accumulated other comprehensive income
are being amortized over the life of the swaps. Changes in fair
value subsequent to March 1, 2019 are reflected on the
consolidated statements of operations in Loss on derivative
instruments (net). Unsecured borrowings-related swaps remain
designated as cash flow hedges for accounting purposes and are
carried on the balance sheet at fair value with related unrealized
gains or losses reflected as a component of Accumulated other
comprehensive income in Stockholders’ equity. Above amounts
exclude variation margin and accrued interest.

 

The following reflects Capstead’s interest rate swaps related
to secured borrowings positions, sorted by quarter of swap
contract expiration. Average fixed rates reflect related swap
fixed-rate payment requirements.

 
      Period of Contract Expiration     Swap Notional

Amounts

    Average

Fixed Rates

Second quarter 2019 $ 1,650,000 1.33 %
Third quarter 2019 550,000 1.40
Fourth quarter 2019 700,000 1.72
First quarter 2020 600,000 2.07
Second quarter 2020 600,000 2.68
Third quarter 2020 200,000 1.64
Fourth quarter 2020 200,000 2.04
First quarter 2021 100,000 2.67
Second quarter 2021 200,000 2.87
Fourth quarter 2021 800,000 2.85
First quarter 2022   2,600,000 2.55
$ 8,200,000
 
     

After consideration of interest rate swaps related to secured
borrowings, Capstead’s residential mortgage investments and
related secured borrowings had durations as of March 31, 2019 of
approximately 13½ months for a net duration gap of approximately
zero months. Duration is a measure of market price sensitivity to
changes in interest rates. A shorter duration generally indicates
less interest rate risk.

 

Contacts

Lindsey Crabbe
(214) 874-2339

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