Capstead Mortgage Corporation Announces Third Quarter 2012 Results

Capstead Mortgage Corporation Announces Third Quarter 2012 Results

Third Quarter 2012 Highlights

• Earnings of $40.0 million or $0.35 per diluted common share

• Average financing spreads on residential mortgage investments decreased 20 basis points to 1.30%

• Book value increased $0.65 to $13.88 per common share

• Portfolio leverage remained relatively stable at approximately eight times long-term investment capital

• Operating costs as a percentage of average long-term investment capital decreased 18 basis points to 0.88%

DALLAS--(BUSINESS WIRE)-- Capstead Mortgage Corporation (NYS: CMO) ("Capstead" or the "Company") today reported net income of $40,037,000 or $0.35 per diluted common share for the quarter ended September 30, 2012. This compares to net income of $43,335,000 or $0.40 per diluted common share for the quarter ended June 30, 2012. The Company paid a third quarter 2012 dividend of $0.36 per common share on October 19, 2012.

Third Quarter Earnings and Related Discussion

Capstead Mortgage Corporation, formed in 1985 and based in Dallas, Texas, is a self-managed real estate investment trust for federal income tax purposes. Capstead earns income from investing in a leveraged portfolio of residential adjustable-rate mortgage pass-through securities, referred to as ARM securities, issued and guaranteed by government-sponsored enterprises, either Fannie Mae or Freddie Mac, or by an agency of the federal government, Ginnie Mae. For the quarter ended September 30, 2012, the Company reported net interest margins of $43,556,000 compared to $47,325,000 for the quarter ended June 30, 2012. Financing spreads on residential mortgage investments averaged 1.30% during the third quarter of 2012, a decline of 20 basis points from financing spreads earned during the second quarter of 2012. Financing spreads on residential mortgage investments is a non-GAAP financial measure based solely on yields on the Company's residential mortgage investments, net of borrowing rates on repurchase arrangements and similar borrowings, adjusted for currently-paying interest rate swap agreements held for hedging purposes - see page 10 for further information.

Yields on Capstead's residential mortgage investments averaged 1.86% during the third quarter of 2012, a decrease of 18 basis points from yields reported for the second quarter of 2012. Yields were negatively impacted primarily by higher investment premium amortization resulting from higher levels of mortgage prepayments. Yields also reflect declines in weighted average coupons on the Company's holdings of currently resetting ARM securities in large part because of recent declines in underlying indices, even as an increasing number of mortgage loans underlying these securities approach fully-indexed levels. Mortgage prepayments expressed as a constant prepayment rate, or CPR, averaged 18.7% during the third quarter of 2012, compared to a CPR of 15.9% during the second quarter of 2012. The Company acquired $1.20 billion (principal amount) of agency-guaranteed ARM securities during the third quarter, most of which were longer-to-reset ARM securities, contributing to a $514 million increase in the portfolio to $14.31 billion at quarter-end.

The following table illustrates the progression of Capstead's portfolio of residential mortgage investments for the quarter and nine months ended September 30, 2012 (dollars in thousands):

Interest rates on repurchase arrangements and similar borrowings, adjusted for currently-paying interest rate swap agreements held as hedges against changes in short-term interest rates, averaged 0.56% during the third quarter of 2012, an increase of two basis points over borrowing rates incurred during the second quarter of 2012, reflecting higher borrowing rates on repurchase arrangements. At September 30, 2012 repurchase arrangements and similar borrowings totaled $13.25 billion, consisting primarily of 30-day borrowings with 24 counterparties and rates averaging 0.41%, before consideration of related interest rate swap agreements. As of September 30, 2012 the Company held currently-paying swap agreements requiring the payment of fixed rates of interest averaging 0.78% on notional amounts totaling $3.70 billion with average remaining interest-payment terms of ten months. Additionally, the Company had entered into forward-starting swap agreements with notional amounts totaling $2.30 billion as of quarter-end that will begin requiring interest payments at fixed rates averaging 0.50% for two-year periods that commence on various dates between October 2012 and October 2013, with an average expiration of 29 months. Variable payments, typically based on one-month LIBOR, that are received by the Company under interest rate swap agreements tend to offset a significant portion of the interest owed on a like amount of the Company's borrowings under repurchase arrangements.

During the third quarter of 2012, Capstead's long-term investment capital, which consists of common and perpetual preferred stockholders' equity and long-term unsecured borrowings (net of related investments in statutory trusts) increased by $83 million to $1.66 billion at quarter-end, primarily as a result of higher portfolio pricing levels. The portfolio was valued at 105.79 at September 30, 2012, an increase of 53 basis points during the quarter, in large part due to continued weak economic conditions and greater expectations for an extended period of low market interest rates. Portfolio leverage (borrowings under repurchase arrangements divided by long-term investment capital) remained relatively stable at 7.96 to one at September 30, 2012 compared to 8.05 to one at June 30, 2012.

Operating costs as a percentage of average long-term investment capital declined to 0.88% during the third quarter of 2012 compared to 1.06% during the second quarter of 2012, due to increases during the year in long-term investment capital as well as lower compensation-related accruals. Compensation-related expense, a significant portion of which is performance-based, increases or decreases with changes in earnings.

Common Equity Issuances

During the third quarter of 2012 Capstead raised $21 million in new common equity capital, after underwriting discounts and offering expenses, by issuing 1.5 million common shares at an average price of $13.93 per share, after expenses, through the Company's at-the-market, continuous offering program. Year-to-date the Company raised $142 million by issuing 10.5 million common shares at an average price of $13.52 per share under this program. The Company may raise additional capital in future periods using this program subject to market conditions and blackout periods associated with the dissemination of earnings and dividend announcements and other important Company-specific news.

Book Value per Common Share

Nearly all of Capstead's residential mortgage investments and all of its interest rate swap agreements are reflected at fair value on the Company's balance sheet and are therefore included in the calculation of book value per common share. The fair value of these investments is impacted by market conditions, including changes in interest rates, and the availability of financing at reasonable rates and leverage levels, among other factors. The Company's investment strategy attempts to mitigate these risks by focusing on investments in agency-guaranteed residential mortgage pass-through securities, which are considered to have little, if any, credit risk and are collateralized by ARM loans with interest rates that reset periodically to more current levels. Because of these characteristics, the fair value of Capstead's portfolio is considerably less vulnerable to significant pricing declines caused by credit concerns or rising interest rates compared to portfolios containing a significant amount of non-agency and/or fixed-rate mortgage securities.

The following table illustrates the progression of Capstead's book value per outstanding common share (calculated assuming liquidation preferences for the Series A and B preferred shares) for the quarter and nine months ended September 30, 2012:

Management Remarks

Commenting on current operating and market conditions, Andrew F. Jacobs, President and Chief Executive Officer, said, "With the apparent weakening of the global economy and the recent announcement by the Federal Reserve Open Market Committee of a significant new fixed-rate mortgage bond buying program referred to as QE3, pricing in the secondary markets for agency-guaranteed residential mortgage securities of all durations, including ARM securities, has risen considerably. While favorable to reported book values, higher pricing levels contribute to lower yields on new acquisitions and puts upward pressure on mortgage prepayment rates as mortgage originators begin offering lower mortgage rates to consumers. During the third quarter the portfolio increased $514 million to $14.31 billion while portfolio leverage declined slightly to 7.96 times our long-term investment capital, from 8.05 times at June 30, 2012 in large part due to increases in our book value as a result of higher portfolio values. In our view, leverage of approximately eight to one represents an appropriate and prudent use of leverage for an agency-guaranteed residential ARM securities portfolio in today's market conditions.

"Mortgage prepayments for the third quarter of 2012 increased approximately 2.8 CPR to 18.7% CPR quarter over quarter reflecting lower prevailing mortgage interest rates available to consumers as well as higher seasonal prepayment patterns. This increase in prepayments contributed to over $5 million in additional investment premium amortization, which negatively impacted portfolio yields and net interest margins for the quarter. While mortgage interest rates may continue declining as a consequence of QE3, we believe certain characteristics of our portfolio lessen the risk of experiencing sharply higher prepayment levels. Central to this belief, and the fundamental difference between our investment portfolio and those of our peers, is our focus on investing solely in ARM securities. As of the end of the third quarter our portfolio was backed by mortgages requiring borrowers to make payments predicated on rates averaging a relatively low 3.37%, of which 56% were originated prior to 2009. Mortgage prepayments on securities backed by more seasoned loans have been partially suppressed by low housing prices and credit problems being experienced by many of these borrowers, even as prepayments on newer originations have increased. As a result, many borrowers with mortgage loans underlying securities in our portfolio lack the ability to meaningfully lower their mortgage payments even if they can overcome all of these impediments to refinancing. For these reasons, we expect mortgage prepayments will remain at manageable levels.

"With the weighted average coupons of an increasing number of mortgage loans underlying our current-reset ARM securities approaching fully-indexed levels, we anticipate the impact to portfolio yields from coupon resets to be relatively modest in the coming quarters, absent significant declines in six- and twelve-month indices. Though slightly higher during the third quarter, our borrowing costs remained largely in check reflecting market expectations that short-term interest rates may stay at extremely low levels into 2015. This has allowed us the opportunity to continue to enter into forward-starting two-year interest rate swap agreements at rates considerably lower than our currently-paying swaps, most of which mature in 2013.

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

Earnings Conference Call Details

An earnings conference call and live audio webcast will be hosted Thursday, October 25, 2012 at 9:00 a.m. ET. The conference call may be accessed by dialing toll free (877) 317-6789 in the U.S., (866) 605-3852 for Canada, or (412) 317-6789 for international callers. A live audio webcast of the conference call can be accessed via the investor relations section of the Company's website at www.capstead.com, and an audio archive of the webcast will be available for approximately 60 days. A replay of the call will be available through November 26, 2012 by dialing toll free (877) 344-7529 in the U.S. or (412) 317-0088 for international callers and entering conference number 10019131.

Cautionary Statement Concerning Forward-looking Statements

This document contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words "believe," "anticipate," "expect," "estimate," "intend," "will be," "will likely continue," "will likely result," or words or phrases of similar meaning. Forward-looking statements are based largely on the expectations of management and are subject to a number of risks and uncertainties including, but not limited to, the following:

• changes in general economic conditions;

• fluctuations in interest rates and levels of mortgage prepayments;

• the effectiveness of risk management strategies;

• the impact of differing levels of leverage employed;

• liquidity of secondary markets and credit markets;

• the availability of financing at reasonable levels and terms to support investing on a leveraged basis;

• the availability of new investment capital;

• the availability of suitable qualifying investments from both an investment return and regulatory perspective;

• changes in legislation or regulation affecting Fannie Mae, Freddie Mac and similar federal government agencies and related guarantees;

• deterioration in credit quality and ratings of existing or future issuances of Fannie Mae, Freddie Mac or Ginnie Mae securities;

• changes in legislation or regulation affecting exemptions for mortgage REITs from regulation under the Investment Company Act of 1940; and

• increases in costs and other general competitive factors.

In addition to the above considerations, actual results and liquidity are affected by other risks and uncertainties which could cause actual results to be significantly different from those expressed or implied by any forward-looking statements included herein. It is not possible to identify all of the risks, uncertainties and other factors that may affect future results. In light of these risks and uncertainties, the forward-looking events and circumstances discussed herein may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. Forward-looking statements speak only as of the date the statement is made and the Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, readers of this document are cautioned not to place undue reliance on any forward-looking statements included herein.