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Capstead Mortgage Corp. Reports Operating Results (10-Q)

November 05, 2009 | About:

Capstead Mortgage Corp. (NYSE:CMO) filed Quarterly Report for the period ended 2009-09-30.

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's core investment strategy is managing a leveraged portfolio of residential mortgage pass-through securities consisting almost exclusively of 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. Agency-guaranteed residential mortgage securities carry an implied AAA credit rating with limited if any credit risk. Capstead Mortgage Corp. has a market cap of $819.3 million; its shares were traded at around $12.59 with a P/E ratio of 6.2 and P/S ratio of 2.1. The dividend yield of Capstead Mortgage Corp. stocks is 17.8%. Capstead Mortgage Corp. had an annual average earning growth of 9.7% over the past 5 years.

Highlight of Business Operations:

Capstead typically finances its investments with its long-term investment capital, which consists of common stockholders equity together with $179 million of perpetual preferred stockholders equity (recorded amount) and $100 million of long-term unsecured borrowings (net of related investments in statutory trusts) supported by its borrowings under repurchase arrangements with commercial banks and other financial institutions. During the nine months ended September 30, 2009, the Companys long-term investment capital increased by $266 million to $1.13 billion, due largely to increases in fair value of the Companys holdings of Agency Securities, along with improved interest rate swap valuations and accretion from capital raises. Together, these factors resulted in a decline in portfolio leverage (borrowings under repurchase arrangements divided by long-term investment capital) from 7.85 to one at year-end to 6.21 to one as of September 30, 2009. Pricing for Agency Securities has benefited from efforts by the federal government to support lower mortgage interest rates and improve overall liquidity in the residential mortgage market. The Companys mortgage securities and similar investments portfolio totaled $7.92 billion at September 30, 2009, an increase of $421 million from year-end.

Capstead earned $42 million and $127 million during the quarter and nine months ended September 30, 2009 compared to $35 million and $102 million during the same periods in 2008 primarily as a result of increased total financing spreads (the difference between yields on the Companys interest-earning assets and rates on interest-bearing liabilities). Total financing spreads averaged 225 basis points during the current quarter, compared to 164 basis points during the same period in 2008, benefiting from significantly lower borrowing rates primarily attributable to lower short-term interest rates.

During the quarter and nine months ended September 30, 2009 Capstead issued 5,147,000 and 5,835,000 common shares at average prices of $14.00 and $13.82 per share ($13.85 and $13.66 per share, net of expenses), respectively, under the Companys continuous offering program. These issuances raised $71 million and $80 million in new common equity capital, after underwriting discounts and offering expenses, respectively. The Company may raise more capital in future periods, subject to market conditions and blackout periods associated with the dissemination of earnings and dividend announcements and other important company-specific news.

Managing a large portfolio of residential mortgage investments consisting primarily of ARM Agency Securities is the core focus of Capsteads investment strategy. As of September 30, 2009, residential mortgage investments totaled $7.87 billion, consisting of over 99% ARM Agency Securities. This compares with residential mortgage investments totaling $7.46 billion as of December 31, 2008. Non-agency-guaranteed residential mortgage investments held by Capstead were limited to $16 million as of September 30, 2009 consisting of well-seasoned, low loan-to-value mortgage loans remaining from a conduit operation operated by the Company in the early 1990s. The Company holds the related credit risk associated with $12 million of these loans, with the remainder held as collateral for structured financings whereby the related credit risk is borne by the securitizations bondholders.

In November 2007 the Company began using two-year term, one- and three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements entered into with four large commercial banks in lieu of longer-term borrowings. Under the terms of the interest rate swap agreements held by Capstead as of September 30, 2009, the Company pays fixed rates of interest averaging 2.76% on notional amounts totaling $2.80 billion with an average maturity of nine months, including agreements with notional amounts totaling $900 million and average fixed rates of 4.03% that terminate in November and December 2009, $800 million with average fixed rates of 2.84% that terminate during the quarter ended March 31, 2010; $200 million with average fixed rates of 3.17% that terminate during the quarter ended June 30, 2010; and $900 million with average fixed rates of 1.33% that terminate between January and September 2011. Variable payments received by the Company under these agreements provide an offset to interest accruing on a like amount of the Companys 30- to 90-day borrowings leaving the fixed-rate payments to be paid on the swap agreements as the Companys effective borrowing rate, subject to certain adjustments including the effects of measured hedge ineffectiveness and the spread between variable rates on the swap agreements and related actual borrowing rates.

In response to deteriorating market conditions experienced the latter part of 2007 and in 2008, Capstead reduced its portfolio leverage during those periods by raising a significant amount of new common equity capital, selling a limited amount of Agency Securities and, when appropriate, curtailing the replacement of portfolio runoff. In addition, the Company increased the number of lending counterparties with which it uses on a regular basis. During 2009, the Company resumed its usual practice of replacing portfolio runoff and deploying new common equity capital into additional holdings of ARM Agency Securities, with a focus on acquiring current-reset ARM securities. Additionally, the Company has experienced a significant increase in the fair value of its portfolio. Year-to-date, acquisitions (consisting primarily of current-reset ARM Agency Securities) totaled $1.31 billion in principal amount with a net WAC of 4.28% and a purchase yield of 2.95%, while portfolio runoff totaled $1.07 billion in principal amount. Combined with a $157 million improvement in pricing of Agency Securities classified as available-for-sale, the Companys holdings of residential mortgage investments increased $411 million in 2009. Total runoff for residential mortgage investments increased during the current quarter to an average annualized rate of 21.7%, while averaging 17.6% year-to-date compared to 18.4% throughout 2008. While trending higher from near-record low levels experienced earlier this year, prepayment rates remain at relatively favorable levels and continue to be restrained by the pronounced contraction seen in residential mortgage lending, largely because of national trends toward declining home values and tighter mortgage loan underwriting standards. 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 investment premiums are written off against earnings as portfolio yield adjustments.

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About the author:

Charlie Tian, Ph.D. - Founder of GuruFocus. You can now order his book Invest Like a Guru on Amazon.

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