Capstead Mortgage Corporation Announces Fourth Quarter 2020 Results
January 27, 2021 at 16:30 PM EST
Capstead Mortgage Corporation (“Capstead” or the “Company”) (NYSE: CMO) today announced financial results for the quarter ended December 31, 2020.
Fourth Quarter 2020 Summary
Fourth Quarter Earnings and Related Discussion
Capstead reported GAAP net income of $23.3 million or $0.19 per diluted common share for the quarter ended December 31, 2020, compared to $29.1 million or $0.25 per diluted common share for the quarter ended September 30, 2020. The Company reported core earnings of $19.7 million or $0.15 per diluted common share for the quarter ended December 31, 2020. This compares to core earnings of $19.9 million or $0.16 per diluted common share for the quarter ended September 30, 2020. See the “Non-GAAP Financial Measures” section of this release for more information on core earnings.
Yields on the Company’s portfolio of agency-guaranteed residential ARM securities averaged 1.55% during the fourth quarter of 2020, a decrease of 30 basis points from 1.85% reported for the third quarter of 2020. Yields declined due to lower coupon interest rates on acquisitions and on existing loans that reset lower based on prevailing interest rates, as well as higher yield adjustments for investment premium amortization due primarily to sustained high mortgage prepayment levels. Mortgage prepayments decreased modestly during the quarter to an average annualized constant prepayment rate (“CPR”) of 38.67%, compared to 39.97% CPR in the prior quarter. Portfolio leverage decreased to 7.26 to one at December 31, 2020 compared to 7.55 to one at September 30, 2020.
The following table illustrates the progression of Capstead’s portfolio of residential mortgage investments for the quarter and year ended December 31, 2020 (dollars in thousands):
Rates on Capstead’s secured borrowings, after adjusting for hedging activities, averaged 30 basis points lower at 0.37% during the fourth quarter of 2020, compared to 0.67% for the prior quarter. Borrowing rates before hedging activities averaged 0.23% during the fourth quarter, a decline of three basis points over the prior quarter. Secured borrowings ended the quarter at $7.32 billion.
Notional amounts of secured borrowings-related interest rate swap agreements averaged $3.51 billion during the fourth quarter of 2020 with fixed swap rates averaging 0.37%. Average fixed swap rates declined 58 basis points from the prior quarter as new swaps were added to hedge acquisitions and replace higher rate swaps at fixed rates of six to 11 basis points for two- to three-year terms reflecting market expectations for a prolonged period of low short-term interest rates. At December 31, 2020, the Company held $2.97 billion notional amount of secured borrowings-related interest rate swaps with fixed rates averaging 0.04%, a decrease of $1.03 billion in notional amount and 65 basis points in rate from swaps held on September 30, 2020. The Company’s duration gap, a measure of interest rate risk, decreased from approximately four months at September 30th to three and one-half months at year-end – see page 10 for further information.
Capstead operates a highly efficient, internally-managed investment platform, particularly compared to other mortgage REITs, and has a competitive cost structure relative to a wide variety of high yielding investment vehicles. Operating costs expressed as an annualized percentage of long-term investment capital averaged 1.19% and 1.28% for the quarter and year ended December 31, 2020. As an annualized percentage of total assets, operating costs averaged 0.14% during these periods.
Book Value per Common Share
Book value per share as of December 31, 2020 was $6.76, a decrease of $0.04 for the quarter. Capstead’s investment strategy attempts to mitigate risks to book value by focusing on investments in agency-guaranteed residential mortgage pass-through securities, which are considered to have little, if any, credit risk and are collateralized by ARM loans with interest rates that reset periodically to more current levels. Because of these characteristics, the fair value of the Company’s portfolio is expected to be less vulnerable to significant pricing declines caused by credit concerns or rising interest rates compared to leveraged portfolios containing a significant amount of non-agency-guaranteed securities or agency-guaranteed securities backed by longer-duration fixed-rate loans. Fair value is impacted by market conditions, including changes in interest rates and the availability of financing at reasonable rates and leverage levels.
Commenting on current operating and market conditions, Phillip A. Reinsch, President and Chief Executive Officer, said, “Our fourth quarter results reflect the stability inherent in our short duration strategy. We declared and paid a $0.15 common dividend for the quarter, which we have now held steady for five quarters. We are the only publicly-traded mortgage REIT to have maintained its dividend payouts and generated core earnings in excess of these dividends over this timeframe.
“Book value was relatively stable for the fourth quarter despite continued high portfolio runoff and a significant increase in longer-term interest rates, with the ten-year U.S. Treasury rate increasing 23 basis points during the quarter to end the year at 0.92%. This was due in large part to strong demand for agency-guaranteed ARM securities relative to supply, fairly stable yields on the shorter part of the yield curve and increases in value of interest rate swaps held for hedging purposes.
“Thus far in 2021, pricing levels for agency-guaranteed ARM securities have been fairly stable relative to a further rise in longer-term interest rates. As of January 22nd, our last internal measurement date, book value per share was lower by approximately $0.01.
“As the financial markets recalibrate for the potential of increased fiscal support from Washington and a strong post-pandemic economy recovery, expectations for further steepening of the yield curve via higher longer term interest rates are growing. Our short duration portfolio should continue to perform well in this environment. Rates on 36% of the mortgages underlying our portfolio are scheduled to reset to more current rates in approximately six months on average, while the rest of the portfolio does so in less than five years on average. This tends to insulate portfolio values and our book value from interest rate-induced bond pricing declines. Additionally, as mortgage coupons reset lower and portfolio runoff is replaced at lower current coupons, incentives for homeowners to refinance are reduced, moderating mortgage prepayment levels over time. Finally, should mortgage interest rates increase as the yield curve steepens, refinancing incentives will be further reduced.
“With strong demand in the market for agency-guaranteed ARM securities and the transition from LIBOR to SOFR-based ARMs limiting production, projected returns on new acquisitions have declined. As a result, we chose not to replace all of our portfolio runoff in the fourth quarter and may not do so in the first quarter of 2021, putting us in position to take advantage of more compelling opportunities should they arise as the year unfolds.”
Non-GAAP Financial Measures
Management believes the presentation of core earnings and core earnings per common share, both non-GAAP financial measures, when analyzed in conjunction with the Company’s GAAP operating results, allows investors to more effectively evaluate the Company’s performance and provides investors management’s view of the Company’s economic performance.
Management also believes that presenting financing spreads on residential mortgage investments, a non-GAAP financial measure, provides important information for evaluating the performance of the Company’s portfolio, as opposed to total financing spreads, because this non-GAAP measure speaks specifically to the performance of the Company’s investment portfolio. See the “Reconciliation of GAAP Measures to Non-GAAP Measures” section of this release.
Earnings Conference Call Details
An earnings conference call and live audio webcast will be hosted Thursday, January 28, 2021 at 9:00 a.m. ET. The conference call may be accessed by dialing toll free (877) 505-6547 in the U.S., (855) 669-9657 for Canada, or (412) 902-6660 for international callers. A live webcast of the conference call can be accessed via the investor relations section of the Company’s website at www.capstead.com and an archive of the webcast will be available up to the date of our next earnings press release. An audio replay can be accessed one hour after the end of the conference call, also up to the date of our next earnings press release, by dialing toll free (877) 344-7529 in the U.S., (855) 669-9658 for Canada, or (412) 317-0088 for international callers and entering conference number 10151735.
Capstead is a self-managed real estate investment trust, or REIT, for federal income tax purposes. The Company earns income from investing in a leveraged portfolio of residential adjustable-rate mortgage pass-through securities, referred to as ARM securities, issued and guaranteed by government-sponsored enterprises, either Fannie Mae or Freddie Mac, or by an agency of the federal government, Ginnie Mae.
Statement Concerning Forward-looking Statements
This document contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “will be,” “will likely continue,” “will likely result,” or words or phrases of similar meaning. Actual results could differ materially from those projected in these forward-looking statements due to a variety of factors, including without limitation, fluctuations in interest rates, the availability of suitable qualifying investments, changes in mortgage prepayments, the availability and terms of financing, changes in market conditions as a result of federal corporate and individual tax law changes, changes in legislation or regulation affecting the mortgage and banking industries or Fannie Mae, Freddie Mac or Ginnie Mae securities, the availability of new investment capital, the liquidity of secondary markets and funding markets, our ability to maintain our qualification as a REIT for U.S. federal tax purposes, our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended, and other changes in general economic conditions. These and other applicable uncertainties, factors and risks are described more fully in the Company’s filings with the U.S. Securities and Exchange Commission.
Forward-looking statements speak only as of the date the statement is made and the Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, readers of this document are cautioned not to place undue reliance on any forward-looking statements included herein.
CAPSTEAD MORTGAGE CORPORATION
The Company defines core earnings as GAAP net income (loss) excluding (a) unrealized (gain) loss on derivative instruments, (b) realized loss (gain) on termination of derivative instruments, (c) amortization of unrealized (gain) loss of derivative instruments held at the time of de-designation, and (d) realized loss (gain) on securities. The following reconciles GAAP net income (loss) and net income (loss) per diluted common share to core earnings and core earnings per common share:
The following reconciles total financing spreads to financing spreads on residential mortgage investments:
After consideration of secured borrowings-related derivative instruments, Capstead’s residential mortgage investments and secured borrowings had durations as of December 31, 2020 of approximately 14 months and 10½ months, respectively, for a net duration gap of approximately 3½ months. Duration is a measure of market price sensitivity to changes in interest rates. A shorter duration generally indicates less interest rate risk.