e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: June 30, 2007
OR
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o |
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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: 1-8896
CAPSTEAD MORTGAGE CORPORATION
(Exact name of Registrant as specified in its Charter)
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Maryland
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75-2027937 |
(State or other jurisdiction of
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(I.R.S. Employer |
incorporation or organization)
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Identification No.) |
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8401 North Central Expressway, Suite 800, Dallas, TX
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75225 |
(Address of principal executive offices)
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(Zip Code) |
Registrants 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 þ NO o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act). (Check one):
Large accelerated filer o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act) YES o NO þ
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the last practicable date.
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Common Stock ($0.01 par value)
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19,392,461 as of August 6, 2007 |
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CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2007
INDEX
-2-
ITEM 1. FINANCIAL STATEMENTS
PART I. ¾ FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
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June 30, 2007 |
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December 31, 2006 |
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(unaudited) |
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(NOTE 2) |
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Assets: |
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Mortgage securities and similar investments
($5.3 billion pledged under repurchase arrangements) |
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$ |
5,490,449 |
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$ |
5,252,399 |
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Investments in unconsolidated affiliates |
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10,523 |
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20,073 |
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Receivables and other assets |
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78,556 |
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69,869 |
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Cash and cash equivalents |
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6,560 |
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5,661 |
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$ |
5,586,088 |
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$ |
5,348,002 |
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Liabilities: |
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Repurchase arrangements and similar borrowings |
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$ |
5,115,170 |
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$ |
4,876,134 |
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Unsecured borrowings |
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103,095 |
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103,095 |
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Common stock dividend payable |
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775 |
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385 |
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Accounts payable and accrued expenses |
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22,400 |
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28,426 |
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5,241,440 |
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5,008,040 |
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Stockholders equity: |
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Preferred stock $0.10 par value; 100,000 shares authorized: |
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$1.60 Cumulative Preferred Stock, Series A,
202 shares issued and outstanding at
June 30, 2007 and December 31, 2006
($3,317 aggregate liquidation preference) |
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2,828 |
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2,828 |
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$1.26 Cumulative Convertible Preferred Stock, Series B,
15,819 shares issued and outstanding at
June 30, 2007 and December 31, 2006
($180,025 aggregate liquidation preference) |
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176,705 |
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176,705 |
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Common stock $0.01 par value; 100,000 shares authorized: |
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19,392 and 19,253 shares issued and outstanding at
June 30, 2007 and December 31, 2006, respectively |
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194 |
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192 |
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Paid-in capital |
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498,208 |
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497,418 |
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Accumulated deficit |
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(352,809 |
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(354,617 |
) |
Accumulated other comprehensive income |
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19,522 |
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17,436 |
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344,648 |
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339,962 |
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$ |
5,586,088 |
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$ |
5,348,002 |
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See accompanying notes to consolidated financial statements.
-3-
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
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Quarter Ended June 30 |
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Six Months Ended June 30 |
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2007 |
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2006 |
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2007 |
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2006 |
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Mortgage securities and similar investments: |
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Interest income |
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$ |
75,795 |
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$ |
57,349 |
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$ |
147,937 |
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$ |
110,275 |
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Interest expense |
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(67,107 |
) |
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(54,685 |
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(130,696 |
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(102,228 |
) |
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8,688 |
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2,664 |
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17,241 |
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8,047 |
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Other revenue (expense): |
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Other revenue |
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237 |
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200 |
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1,108 |
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366 |
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Interest expense on unsecured borrowings |
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(2,187 |
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(1,621 |
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(4,374 |
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(3,208 |
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Other operating expense |
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(1,539 |
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(1,576 |
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(3,213 |
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(3,249 |
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(3,489 |
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(2,997 |
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(6,479 |
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(6,091 |
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Income (loss) before equity in earnings of
unconsolidated affiliates |
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5,199 |
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(333 |
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10,762 |
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1,956 |
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Equity in earnings of unconsolidated affiliates |
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575 |
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608 |
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1,239 |
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1,030 |
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Net income |
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$ |
5,774 |
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$ |
275 |
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$ |
12,001 |
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$ |
2,986 |
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Net income available (loss attributable) to common
stockholders: |
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Net income |
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$ |
5,774 |
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$ |
275 |
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$ |
12,001 |
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$ |
2,986 |
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Less cash dividends paid on preferred stock |
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(5,064 |
) |
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(5,064 |
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(10,128 |
) |
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(10,128 |
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$ |
710 |
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$ |
(4,789 |
) |
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$ |
1,873 |
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$ |
(7,142 |
) |
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Basic and diluted earnings (loss) per common
share |
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$ |
0.04 |
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$ |
(0.25 |
) |
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$ |
0.10 |
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$ |
(0.38 |
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Cash dividends declared per share: |
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Common |
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$ |
0.040 |
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$ |
0.020 |
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$ |
0.060 |
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$ |
0.040 |
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Series A Preferred |
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0.400 |
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0.400 |
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0.800 |
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0.800 |
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Series B Preferred |
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0.315 |
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0.315 |
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0.630 |
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0.630 |
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See accompanying notes to consolidated financial statements.
-4-
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
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Six Months Ended June 30 |
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2007 |
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2006 |
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Operating activities: |
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Net income |
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$ |
12,001 |
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$ |
2,986 |
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Noncash items: |
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Amortization of investment premiums |
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11,808 |
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11,737 |
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Depreciation and other amortization |
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117 |
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50 |
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Stock-based compensation |
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437 |
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244 |
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Undistributed earnings of unconsolidated affiliates |
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(181 |
) |
Net change in receivables, other assets, accounts payable and
accrued expenses |
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(10,378 |
) |
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(13,418 |
) |
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Net cash provided by operating activities |
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13,985 |
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1,418 |
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Investing activities: |
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Purchases of mortgage securities and similar investments |
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(1,153,451 |
) |
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(1,306,819 |
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Principal collections on mortgage securities and similar investments |
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901,280 |
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855,293 |
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Distributions from (investments in) unconsolidated affiliates -
commercial real estate loan limited partnership |
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9,550 |
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(9,218 |
) |
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Net cash used in investing activities of continuing operations |
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(242,621 |
) |
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(460,744 |
) |
Net cash used in investing activities of discontinued operation |
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(2,884 |
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Net cash used in investing activities |
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(242,621 |
) |
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(463,628 |
) |
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Financing activities: |
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Net increase (decrease) in repurchase arrangements and
similar borrowings: |
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Borrowings based on 30-day rates |
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4,175 |
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509,331 |
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Borrowings based on greater than 30-day rates |
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234,862 |
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(70,161 |
) |
Capital stock transactions |
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1,396 |
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(8 |
) |
Dividends paid |
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(10,898 |
) |
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(10,889 |
) |
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Net cash provided by financing activities |
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229,535 |
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428,273 |
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Net change in cash and cash equivalents |
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899 |
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(33,937 |
) |
Cash and cash equivalents at beginning of period |
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5,661 |
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33,937 |
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Cash and cash equivalents at end of period |
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$ |
6,560 |
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$ |
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See accompanying notes to consolidated financial statements.
-5-
CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(unaudited)
NOTE 1 ¾ BUSINESS
Capstead Mortgage Corporation operates as a real estate investment trust for federal income tax
purposes (a REIT) and is based in Dallas, Texas. Unless the context otherwise indicates,
Capstead Mortgage Corporation, together with its subsidiaries, is referred to as Capstead or the
Company. Capstead earns income from investing in real estate-related assets on a leveraged
basis. These investments currently consist primarily of a core portfolio of residential
adjustable-rate mortgage (ARM) securities issued and guaranteed by government-sponsored entities,
either Fannie Mae or Freddie Mac, or by an agency of the federal government, Ginnie Mae
(collectively, Agency Securities). Capstead also seeks to opportunistically invest a portion of
its investment capital in credit-sensitive commercial real estate-related assets, including
subordinate commercial real estate loans.
NOTE 2 ¾ BASIS OF PRESENTATION
Interim Financial Reporting
The accompanying unaudited consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States (GAAP) 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 GAAP 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 and six months ended June 30, 2007 are not necessarily indicative of the results that
may be expected for the calendar year ending December 31, 2007. For further information refer to
the consolidated financial statements and footnotes thereto incorporated by reference in the
Companys annual report on Form 10-K for the year ended December 31, 2006.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation.
Accounting for Uncertainty in Income Taxes
The Company adopted the provisions for Financial Accounting Standards Board (FASB) Interpretation
No. 48, Accounting for Uncertainty in Income Taxes, (FIN 48) on January 1, 2007. The Company
did not recognize any liability for unrecognized tax benefits in implementing FIN 48 and does not
expect to recognize a change in unrecognized tax benefits within the next twelve months. If
applicable, the Company will recognize interest accrued related to unrecognized tax benefits in
interest expense and penalties in operating expenses. No such accruals were necessary as of June
30, 2007. The Company and certain of its subsidiaries file federal and various state income tax
returns. The Company is generally no longer subject to income tax examinations by tax authorities
for years before 2003.
Accounting for Acquisitions of Mortgage Securities Seller-Financed using Repurchase Arrangements
Capstead occasionally finances acquisitions of mortgage investments with the seller using
repurchase arrangements. Consistent with prevailing industry practice, the Company records such
assets and the related borrowings gross on its balance sheet, and the corresponding interest income
and interest expense
-6-
gross on its income statement. In addition, the asset is typically a security held
available-for-sale, and any change in fair value of the asset is recorded as a component of Other
comprehensive income. The Company had less than $25 million in seller-financed acquisitions as of
June 30, 2007.
Under a recent technical interpretation of the pertinent accounting rules, seller-financed
acquisitions may not qualify as a sale from the sellers perspective and the seller may be required
to continue to consolidate the assets sold. As a result, buyers may be precluded from presenting
seller-financed acquisitions gross on their balance sheets and required to treat net investments in
such assets as derivative financial instruments (Derivatives) until such time as the assets are
no longer financed with the sellers. The resulting Derivatives would be marked to market through
earnings. Prior to year-end, the FASB is expected to finalize guidance that would require
consideration as to whether the Derivative accounting described above should be followed in
situations where the acquisition and subsequent financing by a seller is sufficiently linked.
Management does not believe changing the accounting treatment for any past transactions, if
required, would have a material effect on Capsteads reported earnings, taxable income or financial
condition. Also, it would not affect the Companys status as a REIT or cause it to fail to qualify
for its Investment Company Act exemption which requires that the Company must, among other things,
maintain at least 55% of its assets directly in qualifying real estate interests.
Fair Value Accounting Rule Changes
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157). SFAS
No. 157 defines fair value, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. The Company is required to adopt SFAS No. 157 on
January 1, 2008. The adoption of SFAS No. 157 is not expected to have a material impact on the
Companys consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities Including an amendment of FASB Statement No. 115 (SFAS No. 159). This
statement permits, but does not require, entities to measure many financial instruments, including
liabilities and certain other items, at fair value with resulting changes in fair value reported in
earnings. The Company is required to adopt SFAS No. 159 on January 1, 2008 and is currently
evaluating which, if any, of its financial assets or liabilities to report at fair value with
related adjustments reported in earnings. Therefore, the impact, if any, that SFAS No. 159 will
have on its consolidated financial statements has not been determined.
In June 2007, the American Institute of Certified Public Accountants issued Statement of Position
07-1, Clarification of the Scope of the Audit and Accounting Guide Investment Companies and
Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies
(SOP 07-1). SOP 07-1 addresses whether the accounting principles set forth in this audit and
accounting guide are applicable to an entity by clarifying the definition of an investment company
for accounting purposes and eliminating a previous exclusion from the definition for REITs. The
SOP has no bearing on whether an entity is considered an investment company under the Investment
Company Act of 1940. Investment company accounting principles, among other things, require
entities to report investments at fair value with the resulting changes in fair value reported in
earnings. SOP 07-1 is effective January 1, 2008, concurrent with the effective date of SFAS 159.
The Company is currently evaluating whether or not it meets the definition of an investment company
for accounting purposes as set forth in the SOP. Given that most of the Companys investments are
currently reported at fair value with changes in fair value included as a component of
Stockholders equity, the provisions of SOP 07-1, if applicable, are not expected to have a
material impact on the financial condition of the Company and have no impact on future taxable
income; however, future operating results may be more volatile because of the inclusion of fair
value changes in reported earnings.
-7-
NOTE 3 ¾ EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share is computed by dividing net income, after deducting
preferred share dividends, by the weighted average number of common shares outstanding. Diluted
earnings (loss) per common share is computed by dividing net income, after deducting dividends on
convertible preferred shares when such shares are antidilutive, by the weighted average number of
common shares and common share equivalents outstanding, giving effect to equity awards and
convertible preferred shares, when such awards and shares are dilutive. For calculation purposes
the Series A and B preferred shares are considered dilutive whenever basic income per common share
exceeds each Series dividend divided by the conversion rate applicable for that period.
Components of the computation of basic and diluted earnings (loss) per common share were as follows
(in thousands, except per share amounts):
|
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|
|
|
|
|
|
|
|
|
|
|
Quarter Ended |
|
|
Six Months Ended |
|
|
|
June 30 |
|
|
June 30 |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
Numerators for basic earnings (loss) per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
5,774 |
|
|
$ |
275 |
|
|
$ |
12,001 |
|
|
$ |
2,986 |
|
Less Series A and B preferred share dividends |
|
|
(5,064 |
) |
|
|
(5,064 |
) |
|
|
(10,128 |
) |
|
|
(10,128 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available (loss attributable) to common stockholders |
|
$ |
710 |
|
|
$ |
(4,789 |
) |
|
$ |
1,873 |
|
|
$ |
(7,142 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding |
|
|
19,013 |
|
|
|
18,894 |
|
|
|
18,973 |
|
|
|
18,883 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings (loss) per common share |
|
$ |
0.04 |
|
|
$ |
(0.25 |
) |
|
$ |
0.10 |
|
|
$ |
(0.38 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerators for diluted earnings (loss) per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
5,774 |
|
|
$ |
275 |
|
|
$ |
12,001 |
|
|
$ |
2,986 |
|
Less dividends on antidilutive convertible preferred shares |
|
|
(5,064 |
) |
|
|
(5,064 |
) |
|
|
(10,128 |
) |
|
|
(10,128 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available (loss attributable) to common stockholders |
|
$ |
710 |
|
|
$ |
(4,789 |
) |
|
$ |
1,873 |
|
|
$ |
(7,142 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings (loss) per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding |
|
|
19,013 |
|
|
|
18,894 |
|
|
|
18,973 |
|
|
|
18,883 |
|
Net effect of dilutive equity awards |
|
|
244 |
|
|
|
|
|
|
|
182 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19,257 |
|
|
|
18,894 |
|
|
|
19,155 |
|
|
|
18,883 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings (loss) per common share |
|
$ |
0.04 |
|
|
$ |
(0.25 |
) |
|
$ |
0.10 |
|
|
$ |
(0.38 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Potentially dilutive securities excluded from the calculation of diluted earnings (loss) per common
share were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30 |
|
Six Months Ended June 30 |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
Equity awards: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares issuable under option awards |
|
|
406 |
|
|
|
836 |
|
|
|
406 |
|
|
|
836 |
|
Nonvested stock awards |
|
|
|
|
|
|
112 |
|
|
|
|
|
|
|
112 |
|
Convertible preferred shares: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series A shares |
|
|
202 |
|
|
|
202 |
|
|
|
202 |
|
|
|
202 |
|
Series B shares |
|
|
15,819 |
|
|
|
15,819 |
|
|
|
15,819 |
|
|
|
15,819 |
|
-8-
NOTE 4 ¾ MORTGAGE SECURITIES AND SIMILAR INVESTMENTS
Agency Securities carry an implied AAA rating and therefore limited, if any, credit risk. Private
residential mortgage pass-through securities formed prior to 1995 when Capstead operated a mortgage
conduit are referred to as Non-agency Securities. The related credit risk is borne by the
Company or by AAA-rated private mortgage insurers. Commercial loans are subordinate loans that
carry credit risk associated with specific commercial real estate collateral. Collateral for
structured financings consists of Non-agency Securities pledged to secure these securitizations.
The related credit risk is borne by bondholders of the securitization to which the collateral is
pledged. The maturity of mortgage securities is directly affected by the rate of principal
prepayments on the underlying mortgage loans. Mortgage securities and similar investments and
related weighted average rates classified by collateral type and interest rate characteristics were
as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal |
|
|
Investment |
|
|
|
|
|
|
Carrying |
|
|
Net |
|
|
Average |
|
|
|
Balance |
|
|
Premiums |
|
|
Basis |
|
|
Amount (a) |
|
|
WAC (b) |
|
|
Yield (b) |
|
June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae/Freddie Mac: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate |
|
$ |
14,654 |
|
|
$ |
43 |
|
|
$ |
14,697 |
|
|
$ |
14,719 |
|
|
|
6.63 |
% |
|
|
6.36 |
% |
ARMs |
|
|
4,715,121 |
|
|
|
65,873 |
|
|
|
4,780,994 |
|
|
|
4,795,189 |
|
|
|
6.30 |
|
|
|
5.56 |
|
Ginnie Mae ARMs |
|
|
623,079 |
|
|
|
2,698 |
|
|
|
625,777 |
|
|
|
630,656 |
|
|
|
5.66 |
|
|
|
5.45 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,352,854 |
|
|
|
68,614 |
|
|
|
5,421,468 |
|
|
|
5,440,564 |
|
|
|
6.23 |
|
|
|
5.55 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-agency Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate |
|
|
14,873 |
|
|
|
28 |
|
|
|
14,901 |
|
|
|
14,932 |
|
|
|
7.22 |
|
|
|
6.91 |
|
ARMs |
|
|
25,842 |
|
|
|
242 |
|
|
|
26,084 |
|
|
|
26,345 |
|
|
|
7.22 |
|
|
|
6.58 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
40,715 |
|
|
|
270 |
|
|
|
40,985 |
|
|
|
41,277 |
|
|
|
7.22 |
|
|
|
6.70 |
|
Commercial loans |
|
|
2,881 |
|
|
|
|
|
|
|
2,881 |
|
|
|
2,881 |
|
|
|
18.00 |
|
|
|
18.00 |
|
Collateral for structured
financings |
|
|
5,638 |
|
|
|
89 |
|
|
|
5,727 |
|
|
|
5,727 |
|
|
|
8.06 |
|
|
|
7.96 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,402,088 |
|
|
$ |
68,973 |
|
|
$ |
5,471,061 |
|
|
$ |
5,490,449 |
|
|
|
6.25 |
|
|
|
5.57 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae/Freddie Mac: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate |
|
$ |
16,819 |
|
|
$ |
52 |
|
|
$ |
16,871 |
|
|
$ |
16,895 |
|
|
|
6.63 |
% |
|
|
6.29 |
% |
ARMs |
|
|
4,343,740 |
|
|
|
61,381 |
|
|
|
4,405,121 |
|
|
|
4,418,446 |
|
|
|
6.14 |
|
|
|
5.36 |
|
Ginnie Mae ARMs |
|
|
752,301 |
|
|
|
2,757 |
|
|
|
755,058 |
|
|
|
758,660 |
|
|
|
5.23 |
|
|
|
5.20 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,112,860 |
|
|
|
64,190 |
|
|
|
5,177,050 |
|
|
|
5,194,001 |
|
|
|
6.01 |
|
|
|
5.34 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-agency Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate |
|
|
17,734 |
|
|
|
41 |
|
|
|
17,775 |
|
|
|
17,804 |
|
|
|
7.19 |
|
|
|
6.83 |
|
ARMs |
|
|
31,562 |
|
|
|
303 |
|
|
|
31,865 |
|
|
|
32,164 |
|
|
|
6.99 |
|
|
|
6.81 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
49,296 |
|
|
|
344 |
|
|
|
49,640 |
|
|
|
49,968 |
|
|
|
7.06 |
|
|
|
6.81 |
|
Commercial loans |
|
|
2,635 |
|
|
|
|
|
|
|
2,635 |
|
|
|
2,635 |
|
|
|
18.00 |
|
|
|
18.00 |
|
Collateral for structured
financings |
|
|
5,705 |
|
|
|
90 |
|
|
|
5,795 |
|
|
|
5,795 |
|
|
|
8.06 |
|
|
|
7.58 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,170,496 |
|
|
$ |
64,624 |
|
|
$ |
5,235,120 |
|
|
$ |
5,252,399 |
|
|
|
6.03 |
|
|
|
5.36 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Includes mark-to-market for securities classified as available-for-sale, if applicable (see
NOTE 8). |
|
(b) |
|
Net WAC, or weighted average coupon, is presented net of servicing and other fees as of the
indicated balance sheet date. Average Yield is presented for the quarter then ended,
calculated including the amortization of investment premiums, mortgage insurance costs on
Non-agency Securities and excluding unrealized gains and losses. Yields averaged 5.53% for
the six months ended June 30, 2007. |
-9-
Fixed-rate investments generally are mortgage securities backed by mortgage loans that have fixed
rates of interest over the contractual term of the loans. Adjustable-rate investments generally
are ARM securities backed by residential mortgage loans that have coupon interest rates that
adjust at least annually to more current interest rates or begin doing so after an initial
fixed-rate period. After the initial fixed-rate period, if applicable, ARM securities either (i)
adjust annually based on a specified margin over the one-year Constant Maturity U.S. Treasury Note
Rate (CMT) or the one-year London Interbank Offered Rate (LIBOR), (ii) adjust semiannually
based on a specified margin over six-month LIBOR, or (iii) adjust monthly based on a specified
margin over an index such as LIBOR, CMT or the Eleventh District Federal Reserve Bank Cost of
Funds Index, usually subject to periodic and lifetime limits on the amount of such adjustments
during any single interest rate adjustment period and over the contractual term of the loans.
NOTE 5 ¾ INVESTMENTS IN UNCONSOLIDATED AFFILIATES
In July 2005 Capstead and Crescent Real Estate Equities Company (NYSE: CEI) formed a limited
partnership owned and capitalized 75% by Capstead and 25% by CEI, to invest in a leveraged
portfolio of subordinate commercial real estate loans meeting certain criteria over a two-year
investment period that ended in July 2007. CEI sourced investment opportunities (subject to
Capsteads approval) and manages the ventures loan portfolio earning management fees and
incentives based on portfolio performance. Investments made by the partnership are financed using
a committed master repurchase agreement with a major investment banking firm. Amounts available to
be borrowed under this facility and related borrowing rates are dependent upon the characteristics
of the pledged collateral and can change based on changes in the fair value of the pledged
collateral. Amounts borrowed are repayable in four equal installments due quarterly beginning
November 1, 2007. As of June 30, 2007, the partnership had borrowed $28.8 million under this
facility to fund investments totaling $38.3 million consisting of junior liens on a luxury
hospitality property. Capsteads investment in the partnership totaled $7.4 million as of June 30,
2007 and the Companys equity in its earnings totaled $510,000 and $1.1 million during the three
and six months ended June 30, 2007, respectively.
On August 3, 2007 CEI announced the completion of the proposed acquisition of CEI by affiliates of
Morgan Stanley (NYSE: MS) which was approved by a majority vote of CEIs stockholders on August 1,
2007. Capstead is currently evaluating several options relative to the partnership with an
expected resolution by year-end.
To facilitate the issuance of unsecured borrowings, in September and December 2005 and in September
2006 Capstead formed and capitalized a series of three Delaware statutory trusts through the
issuance to the Company of the trusts common securities totaling $3.1 million (see NOTE 7). The
Companys equity in the earnings of the trusts (consisting solely of the common trust securities
pro rata share in interest accruing on Capsteads junior subordinated notes issued to the trusts)
totaled $65,000 and $130,000 during the three and six months ended June 30, 2007, respectively.
NOTE 6 ¾ REPURCHASE ARRANGEMENTS AND SIMILAR BORROWINGS
Capstead generally pledges its Mortgage securities and similar investments as collateral under
uncommitted repurchase arrangements with well-established investment banking firms, the terms and
conditions of which are negotiated on a transaction-by-transaction basis. These repurchase
arrangements generally have maturities of less than 31 days, although the Company routinely extends
maturities on a portion of its borrowings. Interest rates on these borrowings are generally based
on the corresponding LIBOR rate for the maturity of each borrowing. 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, credit quality and liquidity
conditions within the investment banking, mortgage finance and real estate industries. Until 1995
the Company operated a mortgage conduit,
-10-
pooling mortgage loans into Non-agency Securities and issuing structured financings backed by
both Agency and Non-agency Securities. The maturity of outstanding structured financings is
directly affected by the rate of principal prepayments on the related collateral and are subject to
redemption provided certain requirements specified in the related indentures have been met
(referred to as Clean-up Calls). Repurchase arrangements and similar borrowings, classified by
type of collateral and maturities, and related weighted average interest rates were as follows
(dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
December 31, 2006 |
|
|
|
Borrowings |
|
|
Average |
|
|
Borrowings |
|
|
Average |
|
|
|
Outstanding |
|
|
Rate (a) |
|
|
Outstanding |
|
|
Rate (a) |
|
|
Borrowings with maturities of 30 days or less: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities |
|
$ |
2,769,761 |
|
|
|
5.28 |
% |
|
$ |
2,048,151 |
|
|
|
5.30 |
% |
Non-agency Securities |
|
|
36,858 |
|
|
|
5.82 |
|
|
|
45,764 |
|
|
|
5.85 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,806,619 |
|
|
|
5.29 |
|
|
|
2,093,915 |
|
|
|
5.32 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Borrowings with maturities greater than 30 days: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities (31 to 90 days) |
|
|
823,151 |
|
|
|
5.29 |
|
|
|
1,741,751 |
|
|
|
5.16 |
|
Agency Securities (91 to 360 days) |
|
|
25,025 |
|
|
|
4.76 |
|
|
|
|
|
|
|
|
|
Agency Securities (greater than 360 days) |
|
|
1,454,648 |
|
|
|
4.98 |
|
|
|
1,034,673 |
|
|
|
4.98 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,302,824 |
|
|
|
5.09 |
|
|
|
2,776,424 |
|
|
|
5.09 |
|
Structured financings |
|
|
5,727 |
|
|
|
7.96 |
|
|
|
5,795 |
|
|
|
7.58 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,115,170 |
|
|
|
5.20 |
|
|
$ |
4,876,134 |
|
|
|
5.19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Average rate is presented as of the indicated balance sheet date. |
The weighted average effective interest rate on Repurchase arrangements and similar borrowings
was 5.21% and 5.20% during the quarter and six months ended June 30, 2007, respectively.
NOTE 7 ¾ UNSECURED BORROWINGS
Unsecured borrowings consist of 30-year junior subordinated notes issued in September 2005,
December 2005 and September 2006 by Capstead to Capstead Mortgage Trust I, Trust II and Trust III,
respectively. These unconsolidated affiliates of the Company were formed to issue $3.1 million of
the trusts common securities to Capstead and to privately place $100 million of preferred
securities with unrelated third party investors. Note balances and related weighted average
interest rates (calculated including issue cost amortization) listed by trust were as follows
(dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
December 31, 2006 |
|
|
|
Borrowings |
|
|
Average |
|
|
Borrowings |
|
|
Average |
|
|
|
Outstanding |
|
|
Rate (a) |
|
|
Outstanding |
|
|
Rate (a) |
|
|
Junior subordinated notes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capstead Mortgage Trust I |
|
$ |
36,083 |
|
|
|
8.31 |
% |
|
$ |
36,083 |
|
|
|
8.31 |
% |
Capstead Mortgage Trust II |
|
|
41,238 |
|
|
|
8.46 |
|
|
|
41,238 |
|
|
|
8.46 |
|
Capstead Mortgage Trust III |
|
|
25,774 |
|
|
|
8.78 |
|
|
|
25,774 |
|
|
|
8.78 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
103,095 |
|
|
|
8.49 |
|
|
$ |
103,095 |
|
|
|
8.49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Average rate is presented as of the indicated balance sheet date. |
The junior subordinated notes pay interest to the trusts quarterly calculated at fixed rates
of 8.19% to 8.685% for ten years from issuance and subsequently at prevailing three-month LIBOR
rates plus 3.30% to 3.50% for 20 years, reset quarterly. The trusts remit dividends pro rata to
the common and preferred trust securities based on the same terms as the subordinated notes
provided that payments on the trusts common securities are subordinate to payments on the related
preferred securities. The Capstead
-11-
Mortgage Trust I notes and trust securities mature in October 2035 and are redeemable, in whole or
in part, without penalty, at the Companys option anytime on or after October 30, 2010. The
Capstead Mortgage Trust II notes and trust securities mature in December 2035 and are redeemable,
in whole or in part, without penalty, at the Companys option anytime on or after December 15,
2015. The Capstead Mortgage Trust III notes and trust securities mature in September 2036 and are
redeemable, in whole or in part, without penalty, at the Companys option anytime on or after
September 15, 2016. Included in Receivables and other assets are $2.9 million in issue costs
associated with these transactions. The weighted average effective interest rate for Unsecured
borrowings (calculated including issue cost amortization) was 8.49% for both the quarter and six
months ended June 30, 2007.
NOTE 8 ¾ DISCLOSURES REGARDING FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair values of Capsteads financial assets and related liabilities are influenced by changes in,
and market expectations for changes in, interest rates and levels of mortgage prepayments as well
as other factors beyond the control of management. Currently, only investments in mortgage
securities classified as available-for-sale are reported at fair value on the Companys balance
sheet with unrealized gains and losses recorded as a component of Accumulated other comprehensive
income in stockholders equity. Fair value disclosures for available-for-sale securities were as
follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
Unrealized |
|
|
Unrealized |
|
|
Fair |
|
|
|
Basis |
|
|
Gains |
|
|
Losses |
|
|
Value |
|
|
As of June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities |
|
$ |
5,407,057 |
|
|
$ |
25,080 |
|
|
$ |
5,984 |
|
|
$ |
5,426,153 |
|
Non-agency Securities |
|
|
21,084 |
|
|
|
298 |
|
|
|
6 |
|
|
|
21,376 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,428,141 |
|
|
$ |
25,378 |
|
|
$ |
5,990 |
|
|
$ |
5,447,529 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities |
|
$ |
5,160,508 |
|
|
$ |
25,160 |
|
|
$ |
8,209 |
|
|
$ |
5,177,459 |
|
Non-agency Securities |
|
|
25,292 |
|
|
|
334 |
|
|
|
6 |
|
|
|
25,620 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,185,800 |
|
|
$ |
25,494 |
|
|
$ |
8,215 |
|
|
$ |
5,203,079 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value disclosures for mortgage securities classified as held-to-maturity were as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
Unrealized |
|
|
Unrealized |
|
|
Fair |
|
|
|
Basis |
|
|
Gains |
|
|
Losses |
|
|
Value |
|
|
As of June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateral released from structured
financings: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities |
|
$ |
14,411 |
|
|
$ |
202 |
|
|
$ |
3 |
|
|
$ |
14,610 |
|
Non-agency Securities |
|
|
19,901 |
|
|
|
296 |
|
|
|
32 |
|
|
|
20,165 |
|
Collateral for structured financings |
|
|
5,727 |
|
|
|
|
|
|
|
|
|
|
|
5,727 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
40,039 |
|
|
$ |
498 |
|
|
$ |
35 |
|
|
$ |
40,502 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateral released from structured
financings: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities |
|
$ |
16,542 |
|
|
$ |
306 |
|
|
$ |
1 |
|
|
$ |
16,847 |
|
Non-agency Securities |
|
|
24,348 |
|
|
|
328 |
|
|
|
15 |
|
|
|
24,661 |
|
Collateral for structured financings |
|
|
5,795 |
|
|
|
|
|
|
|
|
|
|
|
5,795 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
46,685 |
|
|
$ |
634 |
|
|
$ |
16 |
|
|
$ |
47,303 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-12-
Because most of the Companys investments adjust to more current rates at least annually, or will
begin adjusting annually after an initial fixed-rate period, declines in fair value caused by
increases in interest rates can be largely recovered in a relatively short period of time.
Additionally, these declines tend to be offset by improvements in fair value of longer-dated
repurchase arrangements. Given that managing a large portfolio of primarily ARM mortgage
securities remains the core focus of Capsteads investment strategy, management expects these
securities will be held to maturity. Consequently, temporary declines in value because of
increases in interest rates would not constitute other-than-temporary impairments in value
necessitating writedowns, absent a major shift in the Companys investment focus. Disclosures for
mortgage securities in an unrealized loss position were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
December 31, 2006 |
|
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
|
Value |
|
|
Loss |
|
|
Value |
|
|
Loss |
|
|
Securities in an unrealized loss position: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year or greater |
|
$ |
948,684 |
|
|
$ |
4,997 |
|
|
$ |
837,123 |
|
|
$ |
6,392 |
|
Less than one year |
|
|
794,876 |
|
|
|
1,028 |
|
|
|
487,144 |
|
|
|
1,839 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,743,560 |
|
|
$ |
6,025 |
|
|
$ |
1,324,267 |
|
|
$ |
8,231 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE 9 ¾ COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is net income plus other comprehensive income (loss), which, for the
periods presented, consists primarily of the noncash change in valuation of mortgage securities
classified as available-for-sale. As of June 30, 2007, the Accumulated other comprehensive income
component of Stockholders equity consisted of $19.4 million in net unrealized gains on mortgage
securities held available for sale and $134,000 in amounts related to terminated cash flow hedges.
Disclosures related to comprehensive income (loss) were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended |
|
|
Six Months Ended |
|
|
|
June 30 |
|
|
June 30 |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
Net income |
|
$ |
5,774 |
|
|
$ |
275 |
|
|
$ |
12,001 |
|
|
$ |
2,986 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amounts related to cash flow hedges: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reclassification adjustment for amounts
included in net income |
|
|
(11 |
) |
|
|
(14 |
) |
|
|
(23 |
) |
|
|
(30 |
) |
Amounts related to securities held
available-for-sale: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in valuation of mortgage securities
held available-for-sale |
|
|
(7,357 |
) |
|
|
(8,456 |
) |
|
|
2,109 |
|
|
|
(15,974 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss) |
|
|
(7,368 |
) |
|
|
(8,470 |
) |
|
|
2,086 |
|
|
|
(16,004 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss) |
|
$ |
(1,594 |
) |
|
$ |
(8,195 |
) |
|
$ |
14,087 |
|
|
$ |
(13,018 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE 10 ¾ LONG-TERM INCENTIVE AND OTHER PLANS
The Company sponsors long-term incentive plans to provide for the issuance of stock awards, option
awards and other incentive-based equity awards to directors and employees (collectively, the
Plans). As of June 30, 2007, the Plans had 1,907,957 common shares remaining available for
future issuance. In May and June 2005 stock awards for a total of 172,600 common shares were
issued to directors and employees (average grant date fair value: $7.86 per share) that vest
proportionally over four years, subject to certain restrictions, including continuous service. In
December 2006 stock awards for a total of 197,500 common shares were issued to employees (average
grant date fair value: $8.19 per share) that
-13-
vest over four years, subject to similar restrictions. Also during 2006, stock awards for 21,457
common shares were issued to a new employee and certain directors (average grant date fair value:
$6.86 per share), 6,457 shares of which were vested at grant with the remaining shares vesting
proportionally over three years, subject to similar restrictions. Stock award activity during the
six months ended June 30, 2007 is summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average |
|
|
|
Number of |
|
|
Grant Date |
|
|
|
Shares |
|
|
Fair Value |
|
|
Stock awards outstanding as of December 31, 2006 |
|
|
321,550 |
|
|
$ |
8.02 |
|
Grants issued directors |
|
|
6,000 |
|
|
|
9.81 |
|
Forfeitures |
|
|
(6,250 |
) |
|
|
7.97 |
|
Vested |
|
|
(35,100 |
) |
|
|
7.87 |
|
|
|
|
|
|
|
|
|
Stock awards outstanding as of June 30, 2007 |
|
|
286,200 |
|
|
|
8.07 |
|
|
|
|
|
|
|
|
|
Option awards currently outstanding have contractual terms and vesting requirements at the grant
date of up to ten years and generally have been issued with strike prices equal to the quoted
market prices of the Companys common shares on the date of grant. The fair value of each option
award is estimated on the date of grant using a Black-Scholes option pricing model. The Company
estimates option exercises, expected holding periods and forfeitures based on past experience and
current expectations for option performance and employee/director attrition. The risk-free rate is
based on market rates for the expected life of the option. Expected dividends are based on
historical experience and expectations for future performance. In measuring volatility factors in
recent years, the Company considered volatilities experienced by certain other companies in the
mortgage REIT industry in addition to historical volatilities of Capstead shares given past
circumstances affecting the trading of Capstead shares not expected to reoccur.
During 2005 option awards granted to directors and employees totaled 430,000 shares with an average
price of $7.85 and an average fair value of $0.61 per share, which was determined using average
expected terms of four years, volatility factors of 27%, dividend yields of 10% and risk-free rates
of 3.76%. During 2006 option awards granted to directors and employees totaled 258,000 shares with
an average price of $7.43 and an average fair value of $0.78 per share, which was determined using
average expected terms of four years, volatility factors of 31%, dividend yields of 10% and
risk-free rates of 4.91%. Option award activity during the six months ended June 30, 2007 is
summarized below:
|
|
|
|
|
|
|
|
|
|
|
Number of |
|
|
Weighted Average |
|
|
|
Shares |
|
|
Exercise Price |
|
|
Option awards outstanding as of December 31, 2006 |
|
|
855,552 |
|
|
$ |
13.02 |
|
Grants (average fair value $0.89) (a) |
|
|
220,500 |
|
|
|
10.46 |
|
Expirations |
|
|
(53,520 |
) |
|
|
33.77 |
|
Exercises |
|
|
(2,500 |
) |
|
|
7.82 |
|
|
|
|
|
|
|
|
Option awards outstanding as of June 30, 2007 |
|
|
1,020,032 |
|
|
$ |
11.39 |
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Option awards granted during 2007 were valued with average expected terms of
four years, volatility factors of 27%, dividend yields of 10% and risk-free rates
of 4.60%. |
The weighted average remaining contractual term, average exercise price and aggregate
intrinsic value for the 497,782 exercisable option awards outstanding as June 30, 2007 was five
years, $14.12 and $692,000, respectively. The total intrinsic value of option awards exercised
during 2007 and 2006 was $2,000 and $5,000, respectively. There were no exercises of option awards
in 2005. Unrecognized compensation costs for all unvested equity awards totaled $2.4 million as of
June 30, 2007, to be expensed over a weighted average period of two years.
-14-
The Company also sponsors a qualified defined contribution retirement plan for all employees and a
nonqualified deferred compensation plan for certain of its officers. In general the Company
matches up to 50% of a participants voluntary contribution up to a maximum of 6% of a
participants compensation and discretionary contributions of up to another 3% of compensation
regardless of participation in the plans. All Company contributions are subject to certain vesting
requirements. Contribution expenses were $28,000 and $57,000 for the three and six months ended
June 30, 2007, respectively.
NOTE 11 ¾ CAPITAL RAISING ACTIVITIES
Between May 10, 2007 and June 28, 2007 Capstead sold 137,300 of its common shares into the open
market on a limited basis at an average price of $10.06 per share, after expenses, raising $1.4
million of new common equity capital. These sales were accretive to book value by $0.0136 per
common share and the proceeds were invested in additional ARM Agency Securities. Such sales may
resume in the third quarter.
Also during the second quarter, the Company filed a $500 million shelf registration statement with
the Securities and Exchange Commission in order to facilitate raising additional common equity
capital through the use of more traditional follow-on offerings if market conditions, including the
availability of attractive investment opportunities, allow.
NOTE 12 ¾ NET INTEREST INCOME ANALYSIS
The following tables summarize interest income, interest expense and weighted average interest
rates for Mortgage securities and similar investments and related changes in interest income and
interest expense due to changes in interest rates versus changes in volume (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30 |
|
|
|
|
|
|
2007 |
|
|
2006 |
|
|
Related Changes in |
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
Average |
|
|
Average |
|
|
|
|
|
|
|
Amount |
|
|
Rate |
|
|
Amount |
|
|
Rate |
|
|
Rate* |
|
|
Volume* |
|
|
Interest income |
|
$ |
75,795 |
|
|
|
5.57 |
% |
|
$ |
57,349 |
|
|
|
4.77 |
% |
|
$ |
10,323 |
|
|
$ |
8,123 |
|
Interest expense |
|
|
(67,107 |
) |
|
|
5.21 |
|
|
|
(54,685 |
) |
|
|
4.83 |
|
|
|
4,462 |
|
|
|
7,960 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
8,688 |
|
|
|
0.36 |
|
|
$ |
2,664 |
|
|
|
(0.06 |
) |
|
$ |
5,861 |
|
|
$ |
163 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30 |
|
|
|
|
|
|
2007 |
|
|
2006 |
|
|
Related Changes in |
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
Average |
|
|
Average |
|
|
|
|
|
|
Amount |
|
|
Rate |
|
|
Amount |
|
|
Rate |
|
|
Rate* |
|
|
Volume* |
|
|
Interest income |
|
$ |
147,937 |
|
|
|
5.53 |
% |
|
$ |
110,275 |
|
|
|
4.65 |
% |
|
$ |
22,459 |
|
|
$ |
15,203 |
|
Interest expense |
|
|
(130,696 |
) |
|
|
5.20 |
|
|
|
(102,228 |
) |
|
|
4.61 |
|
|
|
13,851 |
|
|
|
14,617 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
17,241 |
|
|
|
0.33 |
|
|
$ |
8,047 |
|
|
|
0.04 |
|
|
$ |
8,608 |
|
|
$ |
586 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
The change in interest income and interest expense 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. |
-15-
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
Overview
Capstead Mortgage Corporation (together with its subsidiaries, Capstead or the Company)
operates as a real estate investment trust for federal income tax purposes (a REIT) and is based
in Dallas, Texas. Capstead earns income from investing in real estate-related assets on a
leveraged basis. These investments currently consist primarily of a core portfolio of residential
adjustable-rate mortgage (ARM) securities issued and guaranteed by government-sponsored entities,
either Fannie Mae or Freddie Mac, or by an agency of the federal government, Ginnie Mae
(collectively, Agency Securities). Agency Securities carry an implied AAA rating with limited
credit risk.
Capstead also seeks to opportunistically invest a portion of its long-term investment capital in
commercial real estate-related assets, including subordinate commercial real estate loans that have
been prudently underwritten and have attractive risk-adjusted returns. Management believes such
investments can provide earnings support during periods of rising short-term interest rates. As of
June 30, 2007, the Company had committed approximately 2% of its long-term investment capital to
these assets down from 5% at year-end with a June 2007 payoff of a commercial loan position. The
Company did not make any new commercial investments during the first half of 2007. This reflects
managements cautious approach to investing in this sector and attractive opportunities that have
been available to grow the Companys residential mortgage securities portfolio. Over the next
several years the Company may allocate up to 20% of its long-term investment capital to this
sector, as attractive opportunities become available. To this end, the Company has focused its
efforts on developing and expanding capabilities and opportunities to internally source, close and
monitor this type of investment.
The size and composition of Capsteads investment portfolios depend on investment strategies being
implemented by management, the availability of investment capital and overall market conditions,
including the availability of attractively priced investments. Market conditions are influenced
by, among other things, current levels of, and expectations for future levels of, short-term
interest rates and mortgage prepayments.
Capsteads long-term investment capital totaled $445 million as of June 30, 2007, consisting of
$345 million in common and perpetual preferred stockholders equity and $100 million of long-term
unsecured borrowings (net of related investments in statutory trusts). Common stockholders equity
increased approximately $5 million from year-end, attributable primarily to a higher valuation of
the Companys $5.49 billion residential mortgage securities portfolio as a result of increased
portfolio yields.
Financing spreads earned on the Companys mortgage securities and similar investments (the
difference between yields earned on these investments and interest rates charged on related
borrowings) have continued to show improvement during the first half of 2007. Financing spreads
began recovering late in 2006 after having declined steadily, despite increasing portfolio yields,
due to higher borrowing rates because of actions taken by the Federal Open Market Committee (the
Federal Reserve) to increase the federal funds rate a total of 425 basis points to 5.25% between
June 2004 and June 2006. While interest rates on over 70% of the Companys borrowings rise (and
fall) almost immediately in response to changes in short-term interest rates, yields on ARM
securities change slowly by comparison because coupon interest rates on the underlying mortgage
loans may reset only once a year or begin resetting after an initial fixed-rate period and the
amount of each reset can be limited or capped. Yields on the Companys holdings of ARM securities
are expected to continue increasing in the coming quarters. As a result, financing spreads and
financial results are expected to continue to improve, provided the Federal Reserve has finished
raising rates for this interest rate cycle. Should the Federal Reserve eventually lower the
-16-
federal funds rate, improvements in financing spreads and financial results should be more
pronounced then as described in the forward-looking statements included in this filing.
Risk Factors and Critical Accounting Policies
Under the captions Risk Factors and Critical Accounting Policies are discussions of risk
factors and critical accounting policies affecting Capsteads financial condition and results of
operations that are an integral part of this discussion and analysis. Readers are strongly urged
to consider the potential impact of these factors and accounting policies on the Company while
reading this document.
Accounting for Acquisitions of Mortgage Securities Seller-Financed using Repurchase Arrangements
Under a recent interpretation of the related accounting rules, when assets are acquired from and
financed under a repurchase agreement with the same counterparty, the acquisitions may not qualify
as purchases precluding buyers from presenting these assets and related borrowings gross on their
balance sheets and requiring them to treat the net investment in such assets as derivative
financial instruments (Derivatives) until such time as the assets are no longer financed with the
sellers. The resulting Derivatives would be marked to market through earnings. Prior to year-end,
the FASB is expected to finalize guidance that would require consideration as to whether Derivative
accounting should be followed in situations where the acquisition and subsequent financing by a
seller is sufficiently linked. Management does not believe changing the accounting treatment for
any past transactions, if required, would have a material effect on Capsteads reported earnings,
taxable income or financial condition and would not affect its status as a REIT or cause it to fail
to qualify for its Investment Company Act exemption.
Fair Value Accounting Rule Changes
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157). SFAS
No. 157 defines fair value, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. The Company is required to adopt SFAS No. 157 on
January 1, 2008. The adoption of SFAS No. 157 is not expected to have a material impact on the
Companys consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities Including an amendment of FASB Statement No. 115 (SFAS No. 159). This
statement permits, but does not require, entities to measure many financial instruments, including
liabilities and certain other items, at fair value with resulting changes in fair value reported in
earnings. The Company is required to adopt SFAS No. 159 on January 1, 2008 and is currently
evaluating which, if any, of its financial assets or liabilities to report at fair value with
related adjustments reported in earnings. Therefore, the impact, if any, that SFAS No. 159 will
have on its consolidated financial statements has not been determined.
In June 2007, the AICPA issued a statement of position (SOP 07-1) addressing whether accounting
principles set forth in the AICPAs audit and accounting guide for investment companies apply to an
entity by clarifying the definition of an investment company for accounting purposes and
eliminating a previous exclusion from the definition for REITs. SOP 07-1 has no bearing on whether
an entity is considered an investment company under the Investment Company Act. Investment company
accounting principles require reporting investments at fair value with the resulting changes in
fair value reported in earnings. SOP 07-1 is effective January 1, 2008, concurrent with the
effective date of SFAS 159. The Company is currently evaluating whether or not it meets the
definition of an investment company for accounting purposes as set forth in SOP 07-1. Given that
most of the Companys investments are currently reported at fair value with changes in fair value
included as a component of Stockholders equity, the provisions of SOP 07-1, if applicable, are not
expected to have a material impact on the
-17-
financial condition of the Company and have no impact on future taxable income; however, future
operating results may be more volatile because of the inclusion of fair value changes in reported
earnings.
Residential Mortgage Investments
As of June 30, 2007, Capsteads residential mortgage securities portfolio consisted primarily of
ARM Agency Securities. ARM securities held by the Company are backed by residential mortgage loans
that have coupon interest rates that adjust at least annually to more current interest rates or
begin doing so after an initial fixed-rate period. The Company classifies its ARM securities based
on each securitys average number of months until coupon reset (months-to-roll). Current-reset
ARM securities have a months-to-roll of 18 months or less while longer-to-reset ARM securities have
a months-to-roll of greater than 18 months. The average months-to-roll for the Companys $3.50
billion in current-reset ARM securities was less than five months as of June 30, 2007 while the
average months-to-roll for the Companys $1.95 billion in longer-to-reset ARM securities was 45
months. Agency Securities carry an implied AAA-rating with limited credit risk. Non-agency
securities are private mortgage pass-through securities whereby the related credit risk of the
underlying loans is borne by the Company or by AAA-rated private mortgage insurers (Non-agency
Securities). Mortgage securities held by Capstead are generally financed under repurchase
arrangements with investment banking firms pursuant to which specific securities are pledged as
collateral.
During the first six months of 2007, Capstead increased its residential mortgage securities
portfolio nearly $238 million to approximately $5.49 billion with acquisitions of ARM securities
totaling $1.13 billion, more than offsetting $901 million of portfolio runoff. The increase in the
portfolio reflects the deployment of a modest increase in long-term investment capital primarily
attributable to higher portfolio valuations due to increased portfolio yields and the reinvestment
into additional ARM securities of over $9 million of capital available from the payoff of a
commercial loan investment.
Mortgage prepayments increased slightly during the second quarter of 2007 to an annualized runoff
rate of 30% from 28% during the first quarter. Since Capstead typically purchases investments at a
premium to the assets unpaid principal balance, high levels of mortgage prepayments can put
downward pressure on ARM security yields because the level of mortgage prepayments impacts how
quickly these investment premiums are written off against earnings as portfolio yield adjustments.
Prepayments are generally lower during the winter months reflecting seasonal housing patterns in
the United States. As the underlying coupon interest rates on the Companys current-reset ARM
securities reset higher, more of these loans become susceptible to prepayment if prevailing
mortgage interest rates provide an incentive for homeowners with ARM loans to refinance and lock in
attractive longer-term interest rates. Conversely, higher mortgage interest rates can ease
prepayment pressures by removing much of this incentive to refinance. Additionally, ARM loans with
initial fixed-rate periods tend to prepay relatively quickly as the initial fixed-rate period
approaches. Since the Company began significantly increasing the residential mortgage securities
portfolio in late 2005, the overall focus has been on acquiring securities with relatively low
investment premiums and limited prepay protection, when available at attractive pricing, which has
helped lessen the Companys exposure to higher levels of prepayments.
Commercial Real Estate-related Assets
Over the next several years, Capstead may allocate up to 20% of its long-term investment capital to
investments in credit-sensitive commercial real estate-related assets, which will typically consist
of subordinate mortgage loans, or mezzanine debt supported by interests in commercial real estate,
that have been prudently underwritten and have attractive risk-adjusted returns. This strategy is
designed to augment the Companys core portfolio of residential ARM securities by providing an
additional earnings stream that can help support overall earnings during periods of rising
short-term interest rates. As of June 30, 2007, the Company had committed approximately 2% of its
long-term investment capital to these assets down from 5% at year-end with a June 2007 payoff of a
commercial loan position. No new
-18-
commercial investments were made during 2007. This reflects managements cautious approach to this
sector and attractive opportunities that have been available to grow the Companys core portfolio
of residential mortgage securities. Over the past year the Company focused its efforts on
developing and expanding its capabilities and opportunities to make these investments and the
Company is now in a position to internally source, close and monitor these more complicated and
labor-intensive investments.
Commercial mortgage investments as of June 30, 2007 consisted of $7 million invested in a 75%-owned
limited partnership with Crescent Real Estate Equities Company (NYSE: CEI), and several loans
totaling less than $3 million to a Dallas, Texas-based developer. The Companys investment in the
commercial loan partnership is reflected as an unconsolidated affiliate and the commercial loans
are included with mortgage securities and similar investments on the Companys balance sheet.
The partnership with CEI was formed to invest in a leveraged portfolio of subordinated commercial
real estate loans meeting certain criteria over a two-year investment period that ended in July
2007. CEI sourced investment opportunities (subject to Capsteads approval) and manages the loan
portfolio earning management fees and incentives based on portfolio performance. Investments made
by the partnership are currently financed using a committed master repurchase agreement with a
major investment banking firm. Amounts available to be borrowed under this facility and related
borrowing rates are dependent upon the characteristics of the pledged collateral and can change
based on changes in the fair value of the pledged collateral with quarterly repayments of amounts
drawn beginning November 1, 2007. As of June 30, 2007, the partnership had borrowed $29 million
under this facility to fund investments totaling $38 million consisting of junior liens on a luxury
hospitality property in the Caribbean. On August 3, 2007 CEI announced the completion of the
proposed acquisition of CEI by affiliates of Morgan Stanley (NYSE: MS) which was approved by a
majority vote of CEIs stockholders on August 1, 2007. Capstead is currently evaluating several
options relative to the partnership with an expected resolution by year-end.
Book Value per Common Share
The combination of Capsteads reported book value per common share and the mark-to-market of its
longer-term borrowings supporting investments in longer-to-reset ARM securities increased during
the second quarter and year-to-date by $0.07 and $0.45, respectively, primarily as a result of
steadily increasing portfolio yields. Reported book value per common share declined $0.37 during
the second quarter to $8.32 as of June 30, 2007 after having increased $0.56 during the first
quarter, for a net increase of $0.19 year-to-date. The second quarter book value decline was more
than offset by an increase in the fair value of the above-mentioned longer-term borrowings, which
are excluded from the calculation of book value for financial reporting purposes. These borrowings
improved in value by $0.44 during the second quarter to an unrealized gain of $0.41 as of June 30,
2007 after having declined in value $0.18 during the first quarter, for a net improvement of $0.26
year-to-date.
Reported book value per common share is calculated considering the liquidation preferences of the
Companys Series A and B preferred shares and includes unrealized gains and losses on the Companys
residential mortgage securities, most of which are carried at fair value with changes in fair value
reflected in stockholders equity. The fair value of the Companys residential mortgage securities
can be expected to fluctuate with changes in portfolio size and composition as well as changes in
interest rates and market liquidity, and such changes will largely be reflected in book value per
common share. Because most of the Companys investments adjust to more current rates at least
annually, declines in fair value caused by increases in interest rates can be largely recovered in
a relatively short period of time. Book value will also be affected by other factors, including
capital stock transactions and the level of dividend distributions relative to quarterly operating
results; however, temporary changes in fair value of investments not held in the form of
securities, such as commercial real estate loans, generally will not affect book value. As noted
above, the fair value of the Companys liabilities, such as its longer-term borrowings supporting
investments in longer-to-reset ARM securities, are not reflected in book value.
-19-
The fair value of these liabilities tends to move in the opposite direction as the fair value of
the related longer-to-reset securities.
Mortgage Securities and Similar Investments Yield and Cost Analysis
The following yield and cost analysis illustrates results achieved during the second quarter of
2007 for the Companys mortgage securities and similar investments and projected third quarter 2007
annualized portfolio yields, borrowing rates and financing spreads given the assumptions more fully
described in the accompanying notes (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Projected |
|
|
Lifetime |
|
|
|
2nd
Quarter Average |
|
|
As of June 30, 2007 |
|
|
3rd Quarter |
|
|
Runoff |
|
|
|
Basis (a) |
|
|
Yield/Cost |
|
|
Runoff |
|
|
Premiums |
|
|
Basis (a) |
|
|
Yield/Cost (b) |
|
|
Assumptions |
|
|
Agency Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae/Freddie Mac: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate |
|
$ |
15,294 |
|
|
|
6.36 |
% |
|
|
24 |
% |
|
$ |
43 |
|
|
$ |
14,697 |
|
|
|
6.42 |
% |
|
|
38 |
% |
ARMs |
|
|
4,722,469 |
|
|
|
5.56 |
|
|
|
29 |
|
|
|
65,873 |
|
|
|
4,780,994 |
|
|
|
5.70 |
|
|
|
31 |
|
Ginnie Mae ARMs |
|
|
657,306 |
|
|
|
5.45 |
|
|
|
36 |
|
|
|
2,698 |
|
|
|
625,777 |
|
|
|
5.60 |
|
|
|
29 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,395,069 |
|
|
|
5.55 |
|
|
|
30 |
|
|
|
68,614 |
|
|
|
5,421,468 |
|
|
|
5.69 |
|
|
|
31 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-agency Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate |
|
|
15,754 |
|
|
|
6.91 |
|
|
|
34 |
|
|
|
28 |
|
|
|
14,901 |
|
|
|
6.99 |
|
|
|
37 |
|
ARMs |
|
|
27,561 |
|
|
|
6.58 |
|
|
|
37 |
|
|
|
242 |
|
|
|
26,084 |
|
|
|
6.91 |
|
|
|
38 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43,315 |
|
|
|
6.70 |
|
|
|
36 |
|
|
|
270 |
|
|
|
40,985 |
|
|
|
6.94 |
|
|
|
38 |
|
Commercial loans |
|
|
2,838 |
|
|
|
18.00 |
|
|
|
|
|
|
|
|
|
|
|
2,881 |
|
|
|
18.68 |
|
|
|
|
|
Collateral for
structured
financings |
|
|
5,701 |
|
|
|
7.96 |
|
|
|
2 |
|
|
|
89 |
|
|
|
5,727 |
|
|
|
7.96 |
|
|
|
30 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,446,923 |
|
|
|
5.57 |
|
|
|
30 |
|
|
$ |
68,973 |
|
|
|
5,471,061 |
|
|
|
5.70 |
|
|
|
31 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Related borrowings: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30-day LIBOR |
|
|
3,652,138 |
|
|
|
5.29 |
|
|
|
|
|
|
|
|
|
|
|
3,629,770 |
|
|
|
5.29 |
|
|
|
|
|
>30-day LIBOR |
|
|
1,438,464 |
|
|
|
4.98 |
|
|
|
|
|
|
|
|
|
|
|
1,479,673 |
|
|
|
4.99 |
|
|
|
|
|
Structured financings |
|
|
5,701 |
|
|
|
7.96 |
|
|
|
|
|
|
|
|
|
|
|
5,727 |
|
|
|
7.96 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,096,303 |
|
|
|
5.21 |
|
|
|
|
|
|
|
|
|
|
|
5,115,170 |
|
|
|
5.20 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital employed/
financing spread |
|
$ |
350,620 |
|
|
|
0.36 |
|
|
|
|
|
|
|
|
|
|
$ |
355,891 |
|
|
|
0.50 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Return on assets (c) |
|
|
|
|
|
|
0.64 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.72 |
|
|
|
|
|
|
|
|
(a) |
|
Basis represents the Companys investment before unrealized gains and losses. Asset
yields, runoff rates, borrowing rates and resulting financing spread are presented on an
annualized basis. |
|
(b) |
|
Projected annualized yields and borrowing rates reflect anticipated ARM coupon resets and
runoff rates, assuming no change in the federal funds rate during the forecast period and a
gradual rise in the One-Year Treasury Rate, as adjusted for expected third quarter portfolio
acquisitions as of July 26, 2007, the date second quarter earnings were released. Actual
yields realized in future periods largely depend upon (i) changes in portfolio composition,
(ii) actual ARM coupon resets, which can fluctuate from projections based on changes to the
underlying indexes, (iii) actual runoff and (iv) any changes in lifetime runoff assumptions.
Interest rates on borrowings that reset monthly based on 30-day LIBOR largely depend on
changes or anticipated changes in the federal funds rate. As of July 26, 2007, projected
average portfolio yields, borrowing rates, financing spreads and runoff rates over the next
four quarters for Capsteads existing portfolio, (adjusted for expected portfolio
acquisitions through September 30, 2007 only), were as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending |
|
Ending |
|
Portfolio Averages |
|
|
Federal |
|
One-Year |
|
|
|
|
|
Borrowing |
|
Financing |
|
Runoff |
|
|
Funds Rates |
|
Treasury Rate |
|
Yields |
|
Rates |
|
Spreads |
|
Rates |
|
Third Quarter 2007 |
|
|
5.25 |
% |
|
|
5.07 |
% |
|
|
5.70 |
% |
|
|
5.20 |
% |
|
|
0.50 |
% |
|
|
28 |
% |
Fourth Quarter 2007 |
|
|
5.25 |
|
|
|
5.17 |
|
|
|
5.85 |
|
|
|
5.20 |
|
|
|
0.65 |
|
|
|
27 |
|
First Quarter 2008 |
|
|
5.25 |
|
|
|
5.30 |
|
|
|
5.88 |
|
|
|
5.20 |
|
|
|
0.68 |
|
|
|
29 |
|
Second Quarter 2008 |
|
|
5.25 |
|
|
|
5.30 |
|
|
|
5.95 |
|
|
|
5.19 |
|
|
|
0.76 |
|
|
|
28 |
|
|
|
|
(c) |
|
The Company generally uses its liquidity to pay down borrowings. Return on assets is
calculated on an annualized basis assuming the use of this liquidity to reduce borrowing
costs. |
-20-
Yields on Capsteads mortgage securities and similar investments improved during the three and
six months ended June 30, 2007, primarily reflecting the benefits of higher coupon interest rates
on current-reset ARM securities, which constituted 64% of the portfolio as of June 30, 2007. These
securities are expected to continue resetting higher in the coming quarters as the underlying
mortgage loans reset to more current rates. Yields on current-reset ARM securities fluctuate with
changes in mortgage prepayments and adjust to more current interest rates as coupon interest rates
on the underlying mortgage loans reset periodically (typically once or twice a year to a margin
over the corresponding six-month or one-year interest rate index or monthly based on a specified
margin over an index such as one-year U.S. Treasury rates), subject to periodic and lifetime limits
or caps. For example, based on expectations as of July 26, 2007 for relatively stable short-term
interest rates, overall portfolio yields are expected to average 5.70% during the third quarter of
2007 (a 13 basis point increase over average yields for the second quarter of 2007), and the
average yield on the existing portfolio (unadjusted for expected acquisitions beyond September 30,
2007) could approximate 5.95% by the second quarter of 2008 (see footnote (b) on the prior page for
assumptions used in this estimate). Actual yields will depend on portfolio composition as well as
fluctuations in interest rates and mortgage prepayment rates.
Current-reset ARM securities totaled $3.50 billion as of June 30, 2007, and are supported by
borrowings that are re-established monthly at current interest rates based on one-month LIBOR.
One-month LIBOR, which can fluctuate on a daily basis due to market conditions such as actual and
anticipated changes in the federal funds rate, has been relatively stable since the Federal Reserve
stopped raising the federal funds rate last June. Interest rates on the Companys one-month
LIBOR-based borrowings averaged 5.29% for the second quarter of 2007 and should remain at these
levels in the coming quarters, reflecting expectations that one-month LIBOR will remain near
current levels during the remainder of 2007 and into 2008.
Investments in longer-to-reset ARM securities totaled $1.95 billion as of June 30, 2007,
constituting 36% of Capsteads mortgage securities and similar investments. Longer-to-reset ARM
securities are supported to a large extent by longer-term borrowings that effectively lock-in
financing spreads during a significant portion of these investments fixed-rate terms. As of June
30, 2007, such borrowings totaled $1.48 billion at a favorable rate of 4.98% with an average
maturity of 20 months.
Overall financing spreads improved five basis points quarter over quarter to average 36 basis
points during the second quarter of 2007 and it is anticipated that the current recovery in
financing spreads will continue in the coming quarters as asset yields reset higher and borrowing
rates remain relatively stable. As a result, net interest margins and financial results are
expected to continue improving.
Utilization of Long-term Investment Capital and Potential Liquidity
Capstead can generally finance up to 97% of the fair value of its holdings of residential mortgage
securities with well-established investment banking firms using repurchase arrangements with the
balance supported by the Companys long-term investment capital. Long-term investment capital
includes preferred and common equity capital as well as unsecured borrowings, net of Capsteads
investment in related statutory trusts accounted for as unconsolidated affiliates. Assuming
potential liquidity is available, borrowings can be increased or decreased on a daily basis to meet
cash flow requirements and otherwise manage capital resources efficiently. Consequently, the
actual level of cash and cash equivalents carried on Capsteads balance sheet is significantly less
important than the potential liquidity inherent in the Companys investment portfolios. Potential
liquidity is affected by, among other things, changes in market value of assets pledged; principal
prepayments; and general conditions in the investment banking, mortgage finance and real estate
industries. Future levels of financial leverage will be dependent upon many factors, including the
size and composition of the Companys investment portfolios (see Liquidity and Capital
Resources).
-21-
Capsteads utilization of long-term investment capital and potential liquidity were as follows as
of June 30, 2007 in comparison with December 31, 2006 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Related |
|
|
Capital |
|
|
Potential |
|
|
|
Investments (a) |
|
|
Borrowings |
|
|
Employed (a) |
|
|
Liquidity (a) |
|
|
Residential mortgage securities |
|
$ |
5,487,568 |
|
|
$ |
5,115,170 |
|
|
$ |
372,398 |
|
|
$ |
212,208 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate-related assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
|
2,881 |
|
|
|
|
|
|
|
2,881 |
|
|
|
|
|
Investment in commercial
loan partnership |
|
|
7,406 |
|
|
|
|
|
|
|
7,406 |
|
|
|
60 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,497,855 |
|
|
$ |
5,115,170 |
|
|
|
382,685 |
|
|
|
212,268 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other assets, net of other liabilities |
|
|
|
|
|
|
|
|
|
|
62,738 |
|
|
|
6,560 |
|
Second quarter common dividend |
|
|
|
|
|
|
|
|
|
|
(775 |
) |
|
|
(775) |
(b) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
444,648 |
|
|
$ |
218,053 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances as of December 31, 2006 |
|
$ |
5,269,355 |
|
|
$ |
4,876,134 |
|
|
$ |
439,962 |
|
|
$ |
226,330 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Investments are stated at carrying amounts on the Companys balance sheet. Potential
liquidity is based on maximum amounts of borrowings available under existing uncommitted
repurchase arrangements considering the fair value of related collateral as of the indicated
dates adjusted for other sources (uses) of liquidity such as unrestricted cash and cash
equivalents, cash flow (requirements) distributions from the commercial loan partnership and
dividends payable. |
|
(b) |
|
The second quarter 2007 common dividend was declared June 14, 2007 and paid July 20, 2007
to stockholders of record as of June 29, 2007. |
In order to prudently and efficiently manage its liquidity and capital resources, Capstead
maintains sufficient liquidity reserves in the form of potential liquidity to fund margin calls
(requirements to pledge additional collateral or pay down borrowings) required by monthly principal
payments (that are not remitted to the Company for 20 to 45 days after any given month-end) and
potential declines in the market value of pledged assets under stressed market conditions.
-22-
RESULTS OF OPERATIONS
Comparative income statement data (interest income, net of related interest expense, in thousands,
except for per share data) and key portfolio statistics (dollars in millions) were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30 |
|
|
Six Months Ended June 30 |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
Income statement data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage securities and similar investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities |
|
$ |
8,426 |
|
|
$ |
2,525 |
|
|
$ |
16,693 |
|
|
$ |
7,728 |
|
Non-agency Securities |
|
|
134 |
|
|
|
139 |
|
|
|
300 |
|
|
|
319 |
|
Commercial loans |
|
|
128 |
|
|
|
|
|
|
|
248 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,688 |
|
|
|
2,664 |
|
|
|
7,241 |
|
|
|
8,047 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other revenue (expense): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other revenue |
|
|
237 |
|
|
|
200 |
|
|
|
1,108 |
|
|
|
366 |
|
Interest on unsecured borrowings |
|
|
(2,187 |
) |
|
|
(1,621 |
) |
|
|
(4,374 |
) |
|
|
(3,208 |
) |
Other operating expense |
|
|
(1,539 |
) |
|
|
(1,576 |
) |
|
|
(3,213 |
) |
|
|
(3,249 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,199 |
|
|
|
(333 |
) |
|
|
10,762 |
|
|
|
1,956 |
|
Equity in earnings of unconsolidated affiliates |
|
|
575 |
|
|
|
608 |
|
|
|
1,239 |
|
|
|
1,030 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
5,774 |
|
|
$ |
275 |
|
|
$ |
12,001 |
|
|
$ |
2,986 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings (loss) per common share |
|
$ |
0.04 |
|
|
$ |
(0.25 |
) |
|
$ |
0.10 |
|
|
$ |
(0.38 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Key portfolio statistics: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average yields: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities |
|
|
5.55 |
% |
|
|
4.75 |
% |
|
|
5.51 |
% |
|
|
4.63 |
% |
Non-agency Securities |
|
|
6.70 |
|
|
|
6.07 |
|
|
|
6.76 |
|
|
|
5.90 |
|
Commercial loans |
|
|
18.00 |
|
|
|
|
|
|
|
18.00 |
|
|
|
|
|
Collateral for structured financings |
|
|
7.96 |
|
|
|
6.87 |
|
|
|
7.96 |
|
|
|
7.13 |
|
Total average yields |
|
|
5.57 |
|
|
|
4.77 |
|
|
|
5.53 |
|
|
|
4.65 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average related borrowing rates: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30-day LIBOR |
|
|
5.29 |
|
|
|
4.97 |
|
|
|
5.30 |
|
|
|
4.75 |
|
Greater than 30-day LIBOR |
|
|
4.98 |
|
|
|
4.34 |
|
|
|
4.93 |
|
|
|
4.13 |
|
Structured financings |
|
|
7.96 |
|
|
|
6.87 |
|
|
|
7.96 |
|
|
|
7.13 |
|
Total related borrowing rates |
|
|
5.21 |
|
|
|
4.83 |
|
|
|
5.20 |
|
|
|
4.61 |
|
|
Average financing spreads |
|
|
0.36 |
|
|
|
(0.06 |
) |
|
|
0.33 |
|
|
|
0.04 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average portfolio balances: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities |
|
$ |
5,395 |
|
|
$ |
4,736 |
|
|
$ |
5,295 |
|
|
$ |
4,671 |
|
Non-agency Securities |
|
|
43 |
|
|
|
61 |
|
|
|
45 |
|
|
|
63 |
|
Commercial loans |
|
|
3 |
|
|
|
|
|
|
|
3 |
|
|
|
|
|
Collateral for structured financings |
|
|
6 |
|
|
|
7 |
|
|
|
6 |
|
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,447 |
|
|
|
4,804 |
|
|
|
5,349 |
|
|
|
4,742 |
|
Related average borrowings |
|
|
5,096 |
|
|
|
4,472 |
|
|
|
4,999 |
|
|
|
4,406 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average capital deployed |
|
$ |
351 |
|
|
$ |
332 |
|
|
$ |
350 |
|
|
$ |
336 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average portfolio runoff rates: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities |
|
|
30 |
% |
|
|
32 |
% |
|
|
29 |
% |
|
|
31 |
% |
Total |
|
|
30 |
|
|
|
32 |
|
|
|
29 |
|
|
|
31 |
|
-23-
Net margins on Capsteads mortgage securities and similar investments for the three and six months
ended June 30 2007 improved over levels achieved during the same periods of the prior year
reflecting higher financing spreads and larger average holdings of ARM Agency Securities. A 42
basis point increase in average financing spreads during the second quarter of 2007 over the same
period of the prior year contributed most of the improvement in net margins, with portfolio yields
averaging 80 basis points higher during the current quarter while related average borrowing rates
only increased 38 basis points. As a result of a prolonged Federal Reserve rate tightening effort
that increased the federal funds rate 425 basis points over a two year period to 5.25% by June
2006, financing spreads declined steadily during this period, falling to a negative 16 basis points
by the third quarter of 2006 before beginning to recover. Yields on the Companys holdings of ARM
securities are expected to continue increasing in the coming quarters, contributing to further
improvement in financing spreads and net margins assuming short-term interest rates remain stable.
This illustrates how the Company is impacted immediately when short-term interest rates rise (and
fall) while current-reset ARM security yields change slowly in comparison because coupon interest
rates on the underlying mortgage loans may only reset once a year and the amount of each reset can
be limited or capped.
Even as rising short-term interest rates put continued pressure on earnings during 2005 and most of
2006, management remained focused on Capsteads core investment strategy of managing a large
portfolio of ARM Agency Securities with limited, if any, credit risk that can generate attractive
returns over the longer term. Management also focused its efforts on developing its capability to
prudently augment this portfolio with credit-sensitive commercial real estate-related investments
that can provide attractive risk-adjusted returns over the long term with relatively low
sensitivity to changes in interest rates and provide earnings support during periods of rising
short-term interest rates. See Financial Condition Overview, Residential Mortgage
Investments and Commercial Real Estate-related Assets for further discussion of the current
operating environment and the Companys investment strategy.
Average outstanding balances of Agency Securities during the three and six months ended June 30,
2007 increased over $600 million compared to the same periods of the prior year primarily as a
result of the Company fully deploying long-term investment capital raised in late 2005 and in
September 2006. In addition, increases in portfolio valuation during 2007 and the payoff of a $9
million commercial loan investment provided additional liquidity that has been utilized to further
increase the Companys holdings of ARM Agency Securities by nearly $250 million since December 31,
2006. Non-agency Securities contributed slightly less to operating results during the three and
six months ended June 30, 2007 despite higher financing spreads because of lower average balances
outstanding as this legacy portfolio, consisting primarily of released collateral from structured
financings originally issued in the early 1990s, continues to runoff. During the third quarter of
2006 the Company funded several relatively small subordinated loans to a Dallas, Texas-based
developer. Although the Company continues to evaluate opportunities to prudently invest in
credit-sensitive commercial real estate-related assets, no additional investments of this type were
made during the first six months of 2007.
The increase in interest on unsecured borrowings reflects interest charges associated with an
additional $26 million in 10-year fixed, 20-year floating rate junior subordinated notes issued in
September 2006 to a statutory trust formed by the Company. Since September 2005 the Company has
issued $103 million in subordinated notes to statutory trusts. Concurrently, these trusts issued
$3 million of trust common securities to the Company and $100 million in trust preferred securities
to unrelated third parties. Capsteads investments in the trust common securities are accounted
for as unconsolidated affiliates in accordance with the applicable provisions of FASB
Interpretation No. 46 Consolidation of Variable Interest Entities and the subordinated notes are
reflected as unsecured borrowings. The Company considers the $100 million in trust preferred
securities issued to unrelated third parties a component of its long-term investment capital.
-24-
The year-to-date increase in other revenue primarily reflects the first quarter 2007 release of
approximately $1 million in funds held in trust related to certain of the Companys Non-agency
Securities previously designated as collateral for structured financings, net of related taxes.
Any future releases of funds of this nature are expected to be minimal.
Equity in earnings of unconsolidated affiliates includes equity in earnings of the commercial loan
partnership with CEI totaling $510,000 and $1,100,000 during the three and six months ended June
30, 2007, respectively. This venture funded its first investment in August 2005 and its third
investment in February 2006. In June 2007 one of its three outstanding loans repaid lowering the
outstanding portfolio to $38 million. The Companys equity in earnings of its statutory trusts
totaled $65,000 and $130,000 for the three and six months ended June 30, 2007, respectively
(consisting solely of the trust common securities pro rata share in interest on the Companys
junior subordinated notes discussed above).
LIQUIDITY AND CAPITAL RESOURCES
Capsteads primary sources of funds are borrowings under repurchase arrangements and monthly
principal and interest payments on investments in residential and commercial mortgage assets.
Other sources of funds include proceeds from debt and equity offerings and asset sales. The
Company generally uses its liquidity to pay down borrowings under repurchase arrangements to reduce
borrowing costs and otherwise efficiently manage its long-term investment capital. Because the
level of these borrowings can be adjusted on a daily basis, the level of cash and cash equivalents
carried on the balance sheet is significantly less important than the Companys potential liquidity
available under its borrowing arrangements. The table included under Financial Condition
Utilization of Long-term Investment Capital and Potential Liquidity and accompanying discussion
illustrates additional funds potentially available to the Company as of June 30, 2007. The Company
currently believes that it has sufficient liquidity and capital resources available for the
acquisition of additional investments, repayments on borrowings and the payment of cash dividends
as required for Capsteads continued qualification as a REIT. It is the Companys policy to remain
strongly capitalized and conservatively leveraged.
Borrowings under repurchase arrangements secured by residential mortgage securities totaled $5.1
billion at June 30, 2007. Borrowings supporting current-reset ARM securities routinely have
maturities of 30 days or less, while the Company typically finances a significant portion of its
investments in longer-to-reset ARM securities with longer-term arrangements (see discussion above
under Mortgage Securities and Similar Investments Yield and Cost Analysis). Capstead has
uncommitted repurchase facilities with investment banking firms to finance its investments in
residential mortgage securities, subject to certain conditions. Interest rates on these borrowings
are generally based on one-month LIBOR (or a corresponding benchmark rate for longer-term
arrangements) and related terms and conditions 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, credit
quality and liquidity conditions within the investment banking, mortgage finance and real estate
industries.
In May 2007 CEI announced a proposed acquisition of CEI by affiliates of Morgan Stanley (NYSE: MS).
On August 1, 2007 the acquisition was approved by majority vote of CEIs stockholders and on
August 3, 2007 CEI announced the transaction was completed. Capstead is evaluating several options
relative to its commercial loan partnership with CEI that currently has investments totaling $38
million supported by $29 million in borrowings under a committed master repurchase agreement from a
major investment banking firm and $9 million in partners equity (Capsteads 75% share,
approximately $7 million). Quarterly repayments of amounts drawn under the repurchase agreement
begin November 1, 2007 and the Company anticipates reaching a resolution regarding its continued
involvement in this venture by year-end.
-25-
During the latter part of 2005 the Company increased its long-term investment capital through the
issuance of long-term unsecured borrowings for net proceeds of $73 million and in September 2006
raised an additional $24 million in net proceeds through another issuance of unsecured borrowings.
This capital was fully deployed primarily into additional investments in ARM Agency Securities. If
the need arises and such borrowings are available at attractive rates, the Company may further
augment its long-term investment capital with similar borrowings.
During 2004 Capstead raised over $64 million of new common equity through limited open market
sales. No such sales occurred during 2005 or 2006, but sales resumed during the second quarter of
2007 with the issuance of 137,300 common shares at an average price of $10.06, after expenses,
which raised $1.4 million of new common equity capital. These sales were accretive to book value
by $0.0136 per common share and the proceeds were invested in additional ARM Agency Securities.
Such sales may resume in the third quarter. Also during the second quarter, the Company filed a
$500 million shelf registration statement with the Securities and Exchange Commission in order to
facilitate raising additional common equity capital through the use of more traditional follow-on
offerings if market conditions, including the availability of attractive investment opportunities,
allow.
RISK FACTORS
General Discussion of Effects of Interest Rate Changes
Changes in interest rates affect Capsteads earnings in various ways. Earnings currently depend,
in large part, on the difference between the interest received on residential mortgage securities
and the interest paid on related borrowings, most of which are based on one-month LIBOR. In a
rising short-term interest rate environment the resulting financing spread can be reduced or even
turn negative, which adversely affects earnings. Because approximately 64% of the Companys
residential mortgage securities currently consist of current-reset ARM securities, the effects of
rising short-term interest rates on borrowing costs can eventually be mitigated by increases in the
rates of interest earned on the underlying ARM loans, which generally reset periodically to a
margin over a current short-term interest rate index (typically a six-month or one-year index)
subject to periodic and lifetime limits, referred to as caps. Additionally, the Company routinely
extends maturities on a portion of its borrowings, effectively locking in financing spreads over a
significant portion of the fixed-rate terms of the Companys longer-to-reset ARM securities. As of
June 30, 2007, the Companys ARM securities featured the following average current and
fully-indexed weighted average coupon rates, net of servicing and other fees (WAC), net margins,
periodic and lifetime caps, and months-to-roll (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fully |
|
|
Average |
|
|
Average |
|
|
Average |
|
|
Months |
|
|
|
|
|
|
|
Net |
|
|
Indexed |
|
|
Net |
|
|
Periodic |
|
|
Lifetime |
|
|
To |
|
ARM Type |
|
Basis* |
|
|
WAC |
|
|
WAC |
|
|
Margins |
|
|
Caps |
|
|
Caps |
|
|
Roll |
|
|
Current-reset ARMs: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae/Freddie Mac |
|
$ |
2,825,534 |
|
|
|
6.34 |
% |
|
|
6.76 |
% |
|
|
1.85 |
% |
|
|
4.18 |
% |
|
|
10.64 |
% |
|
|
4.4 |
|
Ginnie Mae |
|
|
625,777 |
|
|
|
5.66 |
|
|
|
6.41 |
|
|
|
1.54 |
|
|
|
1.00 |
|
|
|
9.88 |
|
|
|
5.5 |
|
Non-agency Securities |
|
|
26,084 |
|
|
|
7.22 |
|
|
|
7.49 |
|
|
|
2.11 |
|
|
|
1.69 |
|
|
|
11.30 |
|
|
|
5.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,477,395 |
|
|
|
6.22 |
|
|
|
6.70 |
|
|
|
1.80 |
|
|
|
3.59 |
|
|
|
10.51 |
|
|
|
4.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Longer-to-reset ARMs: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae/Freddie Mac |
|
|
1,955,460 |
|
|
|
6.25 |
|
|
|
7.14 |
|
|
|
1.79 |
|
|
|
3.78 |
|
|
|
12.01 |
|
|
|
45.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,432,855 |
|
|
|
6.23 |
|
|
|
6.86 |
|
|
|
1.79 |
|
|
|
3.66 |
|
|
|
11.05 |
|
|
|
19.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Basis represents the Companys investment before unrealized gains and losses. |
-26-
Since only a portion of the ARM loans underlying these securities reset each month, subject to
periodic and lifetime caps, interest rates on related borrowings can rise to levels that may exceed
yields on these securities, contributing to lower or even negative financing spreads and adversely
affecting earnings. At other times, declines in these indices during periods of relatively low
short-term interest rates will negatively affect yields on ARM securities as the underlying ARM
loans reset at lower rates. If declines in these indices exceed declines in the Companys borrowing
rates, earnings would be adversely affected. To provide some protection to financing spreads
against rising interest rates, the Company routinely enters into longer-term repurchase
arrangements on a portion of its borrowings and it may acquire Derivatives such as interest rate
swap or cap agreements. At June 30, 2007, the Company did not own any Derivatives for this
purpose.
When short- and long-term interest rates are at nearly the same levels (i.e., a flat yield curve
environment), or when long-term interest rates decrease, the rate of principal prepayments on
mortgage loans underlying residential mortgage securities generally increases. Prolonged periods
of high mortgage prepayments can significantly reduce the expected life of these investments;
therefore, the actual yields realized can be lower due to faster amortization of investment
premiums. Further, to the extent the proceeds from prepayments 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 be adversely affected. There can be no assurance that suitable investments at
attractive pricing will be available on a timely basis to replace runoff as it occurs.
Investments in junior liens on commercial real estate either held directly or in a joint venture
are either high-coupon loans that are financed entirely with Capsteads investment capital or are
adjustable-rate loans financed with borrowings with similar adjustment features such that related
financing spreads are relatively stable. Because these investments generally are financed with 25%
to 100% investment capital, compared to less than 10% for residential mortgage securities, margins
on these investments will tend to improve when interest rates are increasing and decline when rates
are falling.
Management may determine it is prudent to sell assets from time to time, which can increase
earnings volatility because of the recognition of transactional gains or losses. Such sales may
become attractive as asset values fluctuate with changes in interest rates and market liquidity.
At other times, asset sales may reflect a shift in the Companys investment focus. During periods
of rising interest rates or contracting market liquidity, asset values can decline, leading to
increased margin calls and reducing the Companys liquidity. A margin call means that a lender
requires a borrower to pledge additional collateral to reestablish the agreed-upon ratio of the
value of the collateral to the amount of the borrowing. Although Capstead believes it maintains
sufficient liquidity reserves to fund margin calls required by principal payments and potential
declines in market value of pledged assets, if the Company is unable or unwilling to pledge
additional collateral, lenders can liquidate the collateral under adverse market conditions, likely
resulting in losses.
Interest Rate Sensitivity on Operating Results
Capstead performs earnings sensitivity analysis using an income simulation model to estimate the
effects that specific interest rate changes can reasonably be expected to have on future earnings.
All investments, borrowings and any Derivatives held are included in this analysis. The
sensitivity of components of other revenue (expense) to changes in interest rates is included as
well, although no asset sales are assumed. The model incorporates managements assumptions
regarding the level of mortgage prepayments for a given interest rate change using market-based
estimates of prepayment speeds for the purpose of amortizing investment premiums. These assumptions
are developed through a combination of historical analysis and expectations for future pricing
behavior.
-27-
Capstead had the following estimated earnings sensitivity profile as of June 30, 2007 and
December 31, 2006, respectively (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30-day |
|
10-year U.S. |
|
|
|
|
LIBOR |
|
Treasury |
|
|
|
|
Rate |
|
Rate |
|
Immediate Change In:* |
|
One-month to one-year |
|
|
|
|
|
|
|
|
|
Down |
|
Down |
|
|
|
|
|
|
Up |
|
|
|
Up |
|
interest rates |
|
|
|
|
|
|
|
|
|
|
1.00 |
% |
|
|
1.00 |
% |
|
Flat |
|
|
1.00 |
% |
|
|
1.00 |
% |
|
10-year U.S. Treasury |
|
|
|
|
|
|
|
|
|
Down |
|
|
|
|
|
Down |
|
|
|
|
|
|
Up |
|
rate |
|
|
|
|
|
|
|
|
|
|
1.00 |
% |
|
Flat |
|
|
1.00 |
% |
|
Flat |
|
|
1.00 |
% |
|
Projected 12-month
earnings change: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
5.32 |
% |
|
|
5.03 |
% |
|
$ |
7,700 |
|
|
$ |
10,700 |
|
|
$ |
(6,700 |
) |
|
$ |
(18,000 |
) |
|
$ |
(14,700 |
) |
December 31, 2006 |
|
|
5.32 |
|
|
|
4.70 |
|
|
|
11,900 |
|
|
|
14,300 |
|
|
|
(5,500 |
) |
|
|
(24,700 |
) |
|
|
(21,700 |
) |
|
|
|
* |
|
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
assurance 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 the primary tool used by management to assess the direction and
magnitude of changes in net margins on investments resulting from changes in interest rates. Key
assumptions in the model include mortgage prepayment rates, changes in market conditions and
managements investment 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.
Risks Associated With Credit-Sensitive Investments
Commercial real estate-related assets may be viewed as exposing an investor to greater risk of loss
than residential mortgage securities, particularly Agency Securities, which are guaranteed by
government-sponsored entities or by an agency of the federal government. Commercial mortgage
securities are typically secured by a relatively small pool of loans, and individual commercial
mortgage loans typically have a single obligor. Commercial property values and related cash flows
generated by operations or development activity are often subject to volatility and may be
insufficient to cover debt service on the related financing, including principal repayments, at any
given time.
The repayment of a loan secured by an income-producing property 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
requirements, there can be no assurance that this will continue to be the case in the future. The
repayment of loans secured by development properties is typically dependent upon the successful
development of the property for its intended use and (a) the subsequent lease-up such that the
development becomes a successful income-producing property or (b) the subsequent sale of some or
all of the property for adequate consideration. Even if development activities are completed as
planned, there can be no assurance that subsequent lease-up or sales activity will be sufficient to
cover debt service requirements.
-28-
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 such as natural or man-made disasters. The conversion of
commercial properties to alternate uses often requires substantial capital expenditures, the
funding 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. This could affect the repayment of commercial mortgages. Liquidity of the
credit markets fluctuates and there can be no assurance that liquidity 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.
Junior liens and other forms of subordinated financing on commercial properties carry greater
credit risk than senior lien financing. This is because in the event net cash flows from operating
or developing a commercial property are insufficient to cover all debt service requirements, the
junior liens would generally absorb the shortfall. Declines in current or anticipated net cash
flows, among other factors, can lead to declines in value of the underlying real estate large
enough such that the aggregate outstanding balances of senior and junior liens could exceed the
value of the real estate. In the event of default, the junior lienholder may need to make payments
on the senior loans in order to preserve its rights to the underlying real estate and prevent
foreclosure. Because the senior lienholders generally have priority on proceeds from liquidating
the underlying real estate, junior lienholders may not recover all or any of their investment. To
compensate for this heightened credit risk, these loans generally earn substantially higher yields.
Capstead may leverage its investments in commercial real estate-related assets through the use of
secured borrowing arrangements, the availability and terms of which are predicated on the fair
value of the underlying collateral and liquidity conditions in the credit markets, among other
factors. Similar to investments in residential mortgage securities financed with repurchase
agreements, declines in the value of this collateral could lead to increased margin calls, or loss
of financing altogether, reducing the Companys liquidity and potentially leading to losses from
the sale of the collateral under adverse market conditions.
The availability of capital through secured borrowing arrangements at attractive rates to finance
investments in credit-sensitive commercial real estate-related assets may be diminished during
periods of mortgage finance market illiquidity, which could adversely affect financing spreads and
therefore earnings. The availability of these borrowings at attractive rates ultimately depends
upon the quality of the assets pledged according to the lenders assessment of their credit
worthiness, which could be different from the Companys assessment. Additionally, if overall
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.
Tax Status
As used herein, Capstead REIT refers to Capstead and the entities that are consolidated with
Capstead for federal income tax purposes. Capstead REIT has elected to be taxed as a REIT for
federal income tax purposes and intends to continue to do so. As a result of this election,
Capstead REIT will not be taxed at the corporate level on taxable income distributed to
stockholders, provided certain requirements concerning the nature and composition of its income and
assets are met and that at least 90% of its REIT taxable income is distributed.
-29-
If Capstead REIT were to fail to qualify as a REIT in any taxable year, it would be subject to
federal income tax at regular corporate rates and would not receive a deduction for dividends paid
to stockholders. If this were the case, the amount of after-tax income available for distribution
to stockholders would decrease substantially. As long as Capstead REIT qualifies as a REIT, it will
generally be taxable only on its undistributed taxable income. Distributions out of current or
accumulated taxable earnings and profits will be taxed to stockholders as ordinary income or
capital gain, as the case may be, and will not qualify for the dividend tax rate reduction to 15%
enacted as part of the Jobs and Growth Tax Relief Act of 2002, except as discussed below.
Distributions in excess of Capstead REITs current or accumulated earnings and profits will
constitute a non-taxable return of capital (except insofar as such distributions exceed a
stockholders cost basis of the shares of stock). Distributions by the Company will not be
eligible for the dividends received deduction for corporations. Should the Company incur losses,
stockholders will not be entitled to include such losses in their individual income tax returns.
Capstead may find it advantageous from time to time to elect taxable REIT subsidiary status for
certain of its subsidiaries. Taxable income of a taxable REIT subsidiary is subject to federal and
state income taxes, where applicable. Capstead REITs taxable income will include the income of a
taxable REIT subsidiary only upon distribution of such income to Capstead REIT, and only if any
such distributions are made out of the taxable REIT subsidiarys current or accumulated earnings
and profits as calculated for tax purposes. Should this occur, a portion of Capsteads
distributions to its stockholders could qualify for the 15% dividend tax rate provided by the Jobs
and Growth Tax Relief Act of 2002.
Investment Company Act of 1940
The Investment Company Act of 1940, as amended (the Investment Company Act), exempts from
regulation as an investment company any entity that is primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on, and interests in, real estate.
Capstead conducts its business so as not to become regulated as an investment company. If the
Company were to be regulated as an investment company, Capsteads ability to use leverage would be
substantially reduced and the Company would be unable to conduct business as described herein.
Under the current interpretation of the staff of the Securities and Exchange Commission (SEC), in
order to be exempted from regulation as an investment company, a company like Capstead that invests
in real estate-related assets must, among other things, maintain at least 55% of its assets
directly in qualifying real estate interests. In satisfying this 55% requirement, Capstead may
treat mortgage-backed securities issued with respect to an underlying pool to which it holds all
issued certificates as qualifying real estate interests. If the SEC or its staff adopts a contrary
interpretation of such treatment, Capstead could be required to sell a substantial amount of these
securities or other non-qualified assets under potentially adverse market conditions.
CRITICAL ACCOUNTING POLICIES
Managements discussion and analysis of financial condition and results of operations is based upon
Capsteads consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation of these financial
statements requires the use of estimates and judgments that can affect the reported amounts of
assets, liabilities (including contingencies), revenues and expenses, as well as related
disclosures. These estimates are based on available internal and market information and
appropriate valuation methodologies believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the expected useful lives and carrying values of
assets and liabilities which can materially affect the determination of net income (loss) and book
value per common share. Actual results may differ from these estimates under different assumptions
or conditions.
-30-
Management believes the following are critical accounting policies in the preparation of Capsteads
consolidated financial statements that involve the use of estimates requiring considerable
judgment:
|
|
Amortization of Investment Premiums on Financial Assets
Investment premiums on financial assets are recognized in earnings
as adjustments to interest income by the interest method over the
estimated lives of the related assets. For most of Capsteads
financial assets, estimates and judgments related to future levels
of mortgage prepayments are critical to this determination.
Mortgage prepayment expectations can vary considerably from period
to period based on current and projected changes in interest rates
and other factors such as portfolio composition. Management
estimates mortgage prepayments based on past experiences with
specific investments within the portfolio, and current market
expectations for changes in the interest rate environment. Should
actual runoff rates differ materially from these estimates,
investment premiums would be expensed at a different pace. |
|
|
Fair Value and Impairment Accounting for Financial Assets Most
of Capsteads investments are financial assets held in the form of
mortgage securities that are classified as held available-for-sale
and recorded at fair value on the balance sheet with unrealized
gains and losses recorded in Stockholders equity as a component
of Accumulated other comprehensive income. As such, these
unrealized gains and losses enter into the calculation of book
value per common share, a key financial metric used by investors
in evaluating the Company. Fair values fluctuate with current and
projected changes in interest rates, prepayment expectations and
other factors such as market liquidity. Considerable judgment is
required interpreting market data to develop estimated fair
values, particularly in circumstances of deteriorating credit
quality and market liquidity (see NOTE 8 to the accompanying
unaudited consolidated financial statements for discussion of how
Capstead values its financial assets). Generally, gains or losses
are recognized in earnings only if sold; however, if a decline in
fair value of an individual asset below its amortized cost occurs
that is determined to be other than temporary, the difference
between amortized cost and fair value would be included in Other
revenue (expense) as an impairment charge. |
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. Capsteads actual
results and liquidity can differ materially from those anticipated in these forward-looking
statements because of changes in the level and composition of the Companys investments and
unforeseen factors. These factors may include, but are not limited to, changes in general economic
conditions, the availability of suitable investments from both an investment return and regulatory
perspective, the availability of new investment capital, 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. In addition to the above considerations,
actual results and liquidity related to investments in loans secured by commercial real estate are
affected by borrower performance under operating or development plans, lessee performance under
lease agreements, changes in general as well as local economic conditions and real estate markets,
increases in competition and inflationary pressures, changes in the tax and regulatory environment
including zoning and environmental laws, uninsured losses or losses in excess of insurance limits
and the availability of adequate insurance coverage at reasonable costs, among other 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. Managements Discussion and Analysis of Financial Condition and Results of Operations.
-31-
ITEM 4. CONTROLS AND PROCEDURES
As of June 30, 2007, an evaluation was performed under the supervision and with the participation
of the Companys management, including the Chief Executive Officer (CEO) and Chief Financial
Officer (CFO), of the effectiveness of the design and operation of the Companys disclosure
controls and procedures. Based on that evaluation, the Companys management, including the CEO and
CFO, concluded that the Companys disclosure controls and procedures were effective as of June 30,
2007. There have been no significant changes in the Companys internal controls or in other
factors that could significantly affect internal controls subsequent to June 30, 2007.
PART II. ¾ OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The following Exhibits are presented herewith:
Exhibit 12 Computation of Ratio of Income from Continuing Operations (before fixed charges)
to Combined Fixed Charges and Preferred Stock Dividends.
Exhibit 31.1 Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
Exhibit 32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K:
Current Report on Form 8-K dated May 3, 2007 furnishing the press release announcing first
quarter 2007 results
Current Report on Form 8-K dated May 3, 2007 approving changes to the 2007 compensation of
non-employee directors
Current Report on Form 8-K dated May 4, 2007 announcing a conference call and audio webcast to
discuss first quarter financial results with the investment community
Current Report on Form 8-K dated May 21, 2007 to file a presentation to the investment
community
Current Report on Form 8-K dated June 15, 2007 approving salary increases for the Companys
named executive officers effective July 1, 2007
-32-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CAPSTEAD MORTGAGE CORPORATION |
|
|
|
|
Registrant |
|
|
|
|
|
|
|
|
|
Date: August 6, 2007
|
|
By:
|
|
/s/ ANDREW F. JACOBS |
|
|
|
|
|
|
|
|
|
|
|
|
|
Andrew F. Jacobs |
|
|
|
|
|
|
President and Chief Executive Officer |
|
|
|
|
|
|
|
|
|
Date: August 6, 2007
|
|
By:
|
|
/s/ PHILLIP A. REINSCH |
|
|
|
|
|
|
|
|
|
|
|
|
|
Phillip A. Reinsch |
|
|
|
|
|
|
Executive Vice President and |
|
|
|
|
|
|
Chief Financial Officer |
|
|
-33-