Capstead Mortgage Corporation Announces Second Quarter 2016 Results

DALLAS--(BUSINESS WIRE)--Capstead Mortgage Corporation (NYSE: CMO) (“Capstead” or the “Company”) today announced financial results for the quarter ended June 30, 2016.

Second Quarter 2016 Highlights

• Generated earnings of $21.6 million or $0.19 per diluted common share
• Paid common dividend of $0.23 per common share
• Book value decreased 0.4%, or $0.04, to $11.21 per common share
• Yields on residential mortgage investments decreased 18 basis points to 1.54% while rates on related secured borrowings increased two basis points to 0.84%
• Total financing spreads decreased 18 basis points to 0.64% while financing spreads on residential mortgage investments, a non-GAAP financial measure, decreased 20 basis points to 0.70%
• Agency-guaranteed ARM portfolio and leverage ended the quarter at $13.90 billion and 9.28 times long-term investment capital, respectively

Capstead reported net income of $21.6 million or $0.19 per diluted common share for the quarter ended June 30, 2016. This compares to net income of $27.4 million or $0.25 per diluted common share for the quarter ended March 31, 2016. The Company paid a second quarter 2016 dividend of $0.23 per common share on July 20, 2016.

Second Quarter Earnings and Related Discussion

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 short-duration 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. This strategy differentiates the Company from its peers because the ARM loans underlying its investment portfolio reset to more current interest rates within a relatively short period of time. As a result, the Company is positioned to benefit from future recoveries in financing spreads that typically contract during periods of rising interest rates and to experience smaller fluctuations in portfolio values compared to portfolios containing a significant amount of longer-duration ARM or fixed-rate mortgage securities. Duration is a common measure of market price sensitivity to interest rate movements. A shorter duration generally indicates less interest rate risk.

For the quarter ended June 30, 2016, the Company reported net interest margins of $24.4 million compared to $31.1 million for the quarter ended March 31, 2016. The decrease in net interest margins was primarily attributable to higher investment premium amortization caused by higher mortgage prepayments during the quarter.

Yields on Capstead’s $13.90 billion portfolio of residential mortgage investments averaged 1.54% during the second quarter of 2016, compared to 1.72% reported for the first quarter of 2016. Cash yields (yields on the portfolio before investment premium amortization) increased three basis points to 2.50% largely attributable to mortgage loans underlying the portfolio resetting to higher rates based on higher prevailing six- and 12-month interest rate indices. The negative yield adjustment for investment premium amortization increased 21 basis points to (0.96%) as a result of higher mortgage prepayment levels. Mortgage prepayment rates for the second quarter averaged an annualized constant prepayment rate, or CPR, of 23.19% compared to 18.23% CPR reported for the first quarter of 2016.

The following table illustrates the progression of the Company’s portfolio of residential mortgage investments for the quarter and six months ended June 30, 2016 (dollars in thousands):

Rates on Capstead’s $12.80 billion in secured borrowings, after adjusting for hedging activities, averaged 0.84% during the second quarter of 2016, compared to 0.82% for the first quarter of 2016. Hedging costs increased as older, lower-rate interest rate swap agreements were replaced at higher rates. The Company uses pay-fixed, receive-variable interest rate swap agreements supplemented with longer-maturity secured borrowings when available at attractive rates and terms to help mitigate exposure to rising short-term interest rates. Excluding $700 million notional amount of swap agreements that expired July 1, 2016, at quarter-end the Company held $7.35 billion notional amount of portfolio financing-related swap agreements with contract expirations occurring at various dates through the second quarter of 2019 and a weighted average expiration of 15 months.

Operating costs expressed as an annualized percentage of long-term investment capital averaged 0.93% during the second quarter of 2016 compared to an average of 1.26% for the first quarter of 2016. Operating costs were higher in the first quarter primarily as a result of finalizing 2015 performance-based compensation program results in March 2016. Capstead is a leader in terms of operating cost efficiency among its mortgage REIT peers.

Long-Term Investment Capital, Portfolio Leverage and Book Value per Common Share

Capstead’s long-term investment capital, which consists of common and perpetual preferred stockholders’ equity and $98 million of long-term unsecured borrowings, was largely unchanged during the quarter at $1.38 billion. Portfolio leverage (secured borrowings divided by long-term investment capital) increased to 9.28 to one at June 30, 2016 from 9.14 to one at March 31, 2016, primarily because of higher secured borrowings supporting larger portfolio and cash balances.

The following table illustrates the progression of the Company’s book value per common share (total stockholders’ equity, less preferred share liquidation preferences, divided by shares of common stock outstanding) as well as changes in book value expressed as percentages of beginning book value for the quarter and six months ended June 30, 2016:

Nearly all of Capstead’s residential mortgage investments and all interest rate swap agreements are reflected at fair value on the Company’s balance sheet and related unrealized gains and losses are included in the calculation of book value per common share. The Company’s borrowings, however, are not reflected at fair value on the balance sheet. Fair value is impacted by market conditions, including changes in interest rates, and the availability of financing at reasonable rates and leverage levels, among other factors. The Company’s investment strategy attempts to mitigate these risks 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, generally within five years. Because of these characteristics, the fair value of the Company’s portfolio is 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.

Management Remarks

Commenting on current operating and market conditions, Phillip A. Reinsch, President and Chief Executive Officer, said, “Our second quarter earnings were negatively impacted by higher mortgage prepayment levels due to higher refinancing activity as well as seasonal factors. This contributed to $7.0 million in higher investment premium amortization, more than offsetting the benefits of increasing cash yields. Given the current interest rate environment, we expect further increases in investment premium amortization to weigh on our third quarter results before this refinancing wave begins to dissipate.

“Cash yields benefited from higher coupon interest rate resets as mortgage loans underlying our portfolio of agency-guaranteed residential ARM securities reset to higher rates based on higher prevailing six- and 12-month interest rate indices. We anticipate additional improvements in cash yields in the coming quarters in this rate environment. Regarding borrowing rates, the funding markets remain healthy for financing agency-guaranteed residential mortgage securities leading to expectations for relatively stable borrowing rates given low market expectations for future increases in the Federal Funds Rate.

“We remain confident in and focused on our investment strategy of managing a leveraged portfolio of agency-guaranteed residential ARM securities that can produce attractive risk-adjusted returns over the long term while reducing, but not eliminating, sensitivity to changes in interest rates.”

Earnings Conference Call Details

An earnings conference call and live audio webcast will be hosted Thursday, July 28, 2016 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 audio webcast of the conference call can be accessed via the investor relations section of the Company’s website at www.capstead.com or www.capstead.reit, and an audio archive of the webcast will be available for approximately 60 days. The audio replay will be available one hour after the end of the conference call through October 28, 2016. The replay can be accessed 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 10089598.

Revised Remaining 2016 Common Share Dividend Dates

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.

Forward-looking statements are based largely on the expectations of management and are subject to a number of risks and uncertainties including, but not limited to, the following:

• changes in general economic conditions;
• fluctuations in interest rates and levels of mortgage prepayments;
• the effectiveness of risk management strategies;
• the impact of differing levels of leverage employed;
• liquidity of secondary markets and credit markets;
• the availability of financing at reasonable levels and terms to support investing on a leveraged basis;
• the availability of new investment capital;
• the availability of suitable qualifying investments from both an investment return and regulatory perspective;
• changes in legislation or regulation affecting Fannie Mae, Freddie Mac, Ginnie Mae, the Federal Home Loan Bank system and similar federal government agencies and related guarantees;
• other changes in legislation or regulation affecting the mortgage and banking industries;
• changes in market conditions as a result of Federal Reserve monetary policy or federal government fiscal challenges;
• deterioration in credit quality and ratings of existing or future issuances of Fannie Mae, Freddie Mac or Ginnie Mae securities;
• changes in legislation or regulation affecting exemptions for mortgage REITs from regulation under the Investment Company Act of 1940; and
• increases in costs and other general competitive factors.

In addition to the above considerations, actual results and liquidity are affected by other risks and uncertainties which could cause actual results to be significantly different from those expressed or implied by any forward-looking statements included herein. It is not possible to identify all of the risks, uncertainties and other factors that may affect future results. In light of these risks and uncertainties, the forward-looking events and circumstances discussed herein may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. 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.

Financing spreads on residential mortgage investments, a non-GAAP financial measure, differs from total financing spreads, an all-inclusive GAAP measure, that is based on all interest-earning assets and all interest-paying liabilities. Management believes that presenting financing spreads on residential mortgage investments provides useful information for evaluating the performance of the Company’s portfolio. The following reconciles these two measures:

After consideration of portfolio financing-related swap positions, Capstead’s residential mortgage investments and related secured borrowings had durations as of June 30, 2016 of approximately 10½ and 8¾ months, respectively, for a net duration gap of approximately 1¾ months. Duration is a measure of market price sensitivity to changes in interest rates. A shorter duration generally indicates less interest rate risk.