UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
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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:
OR
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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:
(Exact name of Registrant as specified in its Charter)
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(State or other jurisdiction of |
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(I.R.S. Employer |
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incorporation or organization) |
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Identification No.) |
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(Address of principal executive offices) |
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(Zip Code) |
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(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class |
Trading Symbols |
Name of each exchange on which registered |
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7.50% Series E Cumulative Redeemable Preferred Stock ($0.10 par value) |
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Indicate by check mark whether the registrant (1) has filed all 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 ☑ NO ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES ☑ NO ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
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Common Stock ($0.01par value) |
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CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2020
INDEX
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Page |
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ITEM 1. |
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Consolidated Balance Sheets — September 30, 2020 and December 31, 2019 |
3 |
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Consolidated Statements of Operations — Quarter and Nine Months Ended September 30, 2020 and 2019 |
4 |
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5 |
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6 |
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Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2020 and 2019 |
7 |
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8 |
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ITEM 2. |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
21 |
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ITEM 3. |
35 |
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ITEM 4. |
35 |
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ITEM 1A. |
36
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ITEM 6. |
36 |
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38 |
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-2-
ITEM 1. FINANCIAL STATEMENTS
PART I. — FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except pledged and per share amounts)
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September 30, 2020 |
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December 31, 2019 |
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(unaudited) |
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Assets |
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Residential mortgage investments ($ at September 30, 2020 and December 31, 2019, respectively) |
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$ |
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$ |
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Cash collateral receivable from derivative counterparties |
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Derivatives at fair value |
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– |
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Cash and cash equivalents |
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Receivables and other assets |
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$ |
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$ |
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Liabilities |
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Secured borrowings |
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$ |
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$ |
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Derivatives at fair value |
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Unsecured borrowings |
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Common stock dividend payable |
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Accounts payable and accrued expenses |
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Stockholders’ equity |
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Preferred stock - $ |
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shares issued and outstanding ($ preference) at September 30, 2020 and December 31, 2019 |
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Common stock - $ |
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September 30, 2020 and December 31, 2019, respectively |
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Paid-in capital |
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Accumulated deficit |
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( |
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( |
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Accumulated other comprehensive income |
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$ |
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$ |
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See accompanying notes to consolidated financial statements.
-3-
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
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Quarter Ended |
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Nine Months Ended |
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September 30 |
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September 30 |
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2020 |
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2019 |
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2020 |
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2019 |
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Interest income |
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Residential mortgage investments |
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$ |
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$ |
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$ |
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$ |
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Other |
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Interest expense |
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Secured borrowings |
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( |
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( |
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( |
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( |
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Unsecured borrowings |
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( |
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( |
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( |
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( |
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( |
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( |
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( |
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( |
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Other expense |
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Gain (loss) on derivative instruments (net) |
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( |
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( |
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Loss on sale of investments (net) |
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– |
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– |
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( |
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( |
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Compensation-related expense |
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( |
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( |
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( |
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( |
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Other general and administrative expense |
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( |
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( |
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( |
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( |
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Miscellaneous other revenue (expense) |
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– |
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( |
) |
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( |
) |
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( |
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( |
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( |
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Net income (loss) |
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( |
) |
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( |
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Less preferred stock dividends |
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( |
) |
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( |
) |
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( |
) |
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( |
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Net income (loss) to common stockholders |
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$ |
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$ |
( |
) |
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$ |
( |
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$ |
( |
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Net income (loss) per common share |
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Basic and diluted |
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$ |
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$ |
( |
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$ |
( |
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$ |
( |
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Weighted average common shares outstanding |
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Basic |
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Diluted |
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See accompanying notes to consolidated financial statements.
-4-
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands, unaudited)
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Quarter Ended |
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Nine Months Ended |
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September 30 |
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September 30 |
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2020 |
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2019 |
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2020 |
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2019 |
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Net income (loss) |
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$ |
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$ |
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$ |
( |
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$ |
( |
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Other comprehensive income |
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Amounts related to available for sale securities: |
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Change in net unrealized gain or loss |
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( |
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( |
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( |
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Reclassification adjustment for amounts included in net income (loss) |
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– |
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– |
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Amounts related to cash flow hedges: |
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Change in net unrealized gain or loss |
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( |
) |
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( |
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( |
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Reclassification adjustment for amounts included in net income (loss) |
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( |
) |
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( |
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( |
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( |
) |
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Comprehensive income (loss) |
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$ |
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$ |
( |
) |
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$ |
( |
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$ |
( |
) |
See accompanying notes to consolidated financial statements.
-5-
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, unaudited)
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Preferred Stock |
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Common Stock |
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Paid-in Capital |
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Accumulated Deficit |
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Accumulated Other Comprehensive Income (Loss) |
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Total Stockholders’ Equity |
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Balance at June 30, 2020 |
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$ |
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$ |
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$ |
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$ |
( |
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$ |
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$ |
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Net income |
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– |
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– |
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– |
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– |
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Change in unrealized gain on mortgage securities, net |
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– |
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– |
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– |
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– |
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( |
) |
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( |
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Amounts related to cash flow hedges, net |
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– |
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– |
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– |
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– |
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Cash dividends: |
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Common – $ |
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– |
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– |
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– |
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( |
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– |
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( |
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Preferred – $ |
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– |
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– |
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– |
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( |
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– |
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( |
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Other additions to capital |
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– |
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– |
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– |
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Balance at September 30, 2020 |
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$ |
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$ |
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$ |
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$ |
( |
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$ |
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$ |
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Balance at June 30, 2019 |
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$ |
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$ |
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$ |
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$ |
( |
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$ |
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$ |
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Net income |
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– |
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– |
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– |
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– |
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Change in unrealized gain on mortgage securities, net |
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– |
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– |
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– |
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– |
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( |
) |
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( |
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Amounts related to cash flow hedges, net |
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– |
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– |
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– |
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– |
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( |
) |
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( |
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Cash dividends: |
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Common – $ |
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– |
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– |
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– |
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( |
) |
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– |
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( |
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Preferred – $ |
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– |
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– |
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– |
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( |
) |
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– |
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( |
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Issuance of common stock |
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– |
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– |
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– |
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Other additions to capital |
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– |
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– |
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– |
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Balance at September 30, 2019 |
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$ |
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$ |
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$ |
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$ |
( |
) |
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$ |
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$ |
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Balance at December 31, 2019 |
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$ |
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$ |
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$ |
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$ |
( |
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$ |
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$ |
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Net loss |
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– |
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– |
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– |
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( |
) |
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– |
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( |
) |
||||
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Change in unrealized gain on mortgage securities, net |
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– |
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– |
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– |
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– |
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Amounts related to cash flow hedges, net |
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– |
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– |
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– |
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– |
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( |
) |
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( |
) |
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Cash dividends: |
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Common – $ |
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– |
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– |
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– |
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( |
) |
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– |
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( |
) |
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Preferred – $ |
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– |
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– |
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– |
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( |
) |
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– |
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( |
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Issuance of common stock |
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– |
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– |
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– |
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|||
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Other additions to capital |
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– |
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– |
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– |
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|||
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Balance at September 30, 2020 |
|
$ |
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$ |
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$ |
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$ |
( |
) |
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$ |
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$ |
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Balance at December 31, 2018 |
|
$ |
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$ |
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$ |
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$ |
( |
) |
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$ |
( |
) |
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$ |
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Net loss |
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– |
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– |
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– |
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( |
) |
|
– |
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( |
) |
||||
|
Change in unrealized gain on mortgage securities, net |
|
– |
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– |
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– |
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– |
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||||
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Amounts related to cash flow hedges, net |
|
– |
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– |
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|
– |
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– |
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( |
) |
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( |
) |
||||
|
Cash dividends: |
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Common – $ |
|
– |
|
|
– |
|
|
– |
|
|
|
( |
) |
|
– |
|
|
|
( |
) |
||||
|
Preferred – $ |
|
– |
|
|
– |
|
|
– |
|
|
|
( |
) |
|
– |
|
|
|
( |
) |
||||
|
Issuance of common stock |
|
– |
|
|
|
|
|
|
|
|
|
|
– |
|
|
– |
|
|
|
|
|
|||
|
Other additions to capital |
|
– |
|
|
|
|
|
|
|
|
|
|
– |
|
|
– |
|
|
|
|
|
|||
|
Balance at September 30, 2019 |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
( |
) |
|
$ |
|
|
|
$ |
|
|
See accompanying notes to consolidated financial statements.
-6-
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
|
|
|
Nine Months Ended September 30 |
|
|||||
|
|
|
2020 |
|
|
2019 |
|
||
|
Operating activities |
|
|
|
|
|
|
|
|
|
Net loss |
|
$ |
( |
) |
|
$ |
( |
) |
|
Adjustments to reconcile net loss to cash provided by operating activities: |
|
|
|
|
|
|
|
|
|
Amortization of investment premiums |
|
|
|
|
|
|
|
|
|
Amortization of equity-based awards |
|
|
|
|
|
|
|
|
|
Amortization of unrealized gain on de-designated hedges |
|
|
|
|
|
|
( |
) |
|
Loss on sale of mortgage investments |
|
|
|
|
|
|
|
|
|
Loss on derivative instruments (net) |
|
|
|
|
|
|
|
|
|
Other depreciation and amortization |
|
|
|
|
|
|
|
|
|
Net change in receivables, other assets, accounts payable and accrued expenses |
|
|
( |
) |
|
|
|
|
|
Net cash provided by operating activities |
|
|
|
|
|
|
|
|
|
Investing activities |
|
|
|
|
|
|
|
|
|
Purchases of residential mortgage investments |
|
|
( |
) |
|
|
( |
) |
|
Proceeds from sales of residential mortgage investments |
|
|
|
|
|
|
|
|
|
Interest receivable acquired with the purchase of residential mortgage investments |
|
|
( |
) |
|
|
( |
) |
|
Principal collections on residential mortgage investments, including changes in mortgage securities principal remittance receivable |
|
|
|
|
|
|
|
|
|
Redemption of lending counterparty investments |
|
|
– |
|
|
|
|
|
|
Net cash provided by investing activities |
|
|
|
|
|
|
|
|
|
Financing activities |
|
|
|
|
|
|
|
|
|
Proceeds from secured borrowings |
|
|
|
|
|
|
|
|
|
Principal payments on secured borrowings |
|
|
( |
) |
|
|
( |
) |
|
Decrease in cash collateral receivable from derivative counterparties |
|
|
( |
) |
|
|
( |
) |
|
Net payments on derivative settlements |
|
|
( |
) |
|
|
( |
) |
|
Issuance of common stock |
|
|
|
|
|
|
|
|
|
Other capital stock transactions |
|
|
( |
) |
|
|
( |
) |
|
Dividends paid |
|
|
( |
) |
|
|
( |
) |
|
Net cash used in financing activities |
|
|
( |
) |
|
|
( |
) |
|
Net change in cash and cash equivalents |
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at beginning of period |
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
|
|
|
$ |
|
|
See accompanying notes to consolidated financial statements.
-7-
CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2020
(unaudited)
NOTE 1 — BUSINESS
Capstead Mortgage Corporation operates as a self-managed 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 a leveraged portfolio of residential mortgage pass-through securities consisting almost exclusively of adjustable-rate mortgage (“ARM”) securities issued and guaranteed by government-sponsored enterprises, either Fannie Mae, Freddie Mac, or by an agency of the federal government, Ginnie Mae. Residential mortgage pass-through securities guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae are referred to as “Agency Securities” and are considered to have limited, if any, credit risk.
NOTE 2 — 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 nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2020. For further information refer to the audited consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2019.
Recent Accounting Pronouncements
In June 2016, the FASB issued Accounting Standards Update No. 2016-13, Financial Instruments – Credit Losses (“ASU 2016-13”) which replaced the incurred loss impairment methodology in previous GAAP with a methodology that is designed to better reflect expected credit losses. For financial instruments carried at amortized cost, impairment is measured as a current estimate of expected lifetime credit losses. For available-for-sale debt securities in which changes in fair value are recorded in accumulated other comprehensive income, the FASB replaced the write-down of available-for-sale securities under the “other-than-temporarily” impaired model with an allowance for credit losses model. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. The Company adopted ASU 2016-13 on January 1, 2020 which had no material effect on the Company’s results of operations, financial condition and cash flows primarily due to the limited, if any, credit risk of Agency Securities.
NOTE 3 — NET INCOME (LOSS) PER COMMON SHARE
Basic net income (loss) per common share is computed by dividing net income, after deducting dividends paid or accrued on preferred stock and allocating earnings to equity awards deemed to be participating securities pursuant to the two-class method, by the average number of shares of common stock outstanding, calculated excluding unvested equity awards. Participating securities include unvested equity awards that contain non-forfeitable rights to dividends prior to vesting.
-8-
Diluted net income (loss) per common share is computed by dividing the numerator used to compute basic net income (loss) per common share by the denominator used to compute basic net income (loss) per common share, further adjusted for the dilutive effect, if any, of equity awards and shares of preferred stock when and if convertible into shares of common stock. Shares of the Company’s
|
|
|
Quarter Ended |
|
|
Nine Months Ended |
|
||||||||||
|
|
|
September 30 |
|
|
September 30 |
|
||||||||||
|
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||
|
Basic net income (loss) per common share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator for basic net income (loss) per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
|
|
|
$ |
|
|
|
$ |
( |
) |
|
$ |
( |
) |
|
Preferred stock dividends |
|
|
( |
) |
|
|
( |
) |
|
|
( |
) |
|
|
( |
) |
|
Earnings participation of unvested equity awards |
|
|
( |
) |
|
|
( |
) |
|
|
( |
) |
|
|
( |
) |
|
|
|
$ |
|
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|
Denominator for basic net income (loss) per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average number of shares of common stock outstanding |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average unvested stock awards outstanding |
|
|
( |
) |
|
|
( |
) |
|
|
( |
) |
|
|
( |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|
Diluted net income (loss) per common share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator for diluted net income (loss) per common share |
|
$ |
|
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted net income (loss) per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic net income (loss) per common share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net effect of dilutive equity awards |
|
|
|
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
Anti-dilutive securities that could be potentially dilutive in the future that were not included in the computation of diluted net income (loss) per common share include
-9-
NOTE 4 — RESIDENTIAL mortgage investments
Residential mortgage investments classified by collateral type and interest rate characteristics as of the indicated dates were as follows (dollars in thousands):
|
|
|
Unpaid Principal Balance |
|
|
Investment Premiums |
|
|
Amortized Cost Basis |
|
|
Carrying Amount (a) |
|
|
Net WAC (b) |
|
|
Average Yield (c) |
|
||||||
|
September 30, 2020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae/Freddie Mac: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate |
|
$ |
|
|
|
$ |
– |
|
|
$ |
|
|
|
$ |
|
|
|
|
|
% |
|
|
|
% |
|
ARMs |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ginnie Mae ARMs |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage loans: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate |
|
|
|
|
|
– |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ARMs |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateral for structured financings |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae/Freddie Mac: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate |
|
$ |
|
|
|
$ |
– |
|
|
$ |
|
|
|
$ |
|
|
|
|
|
% |
|
|
|
% |
|
ARMs |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ginnie Mae ARMs |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage loans: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ARMs |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateral for structured financings |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
|
(b) |
|
|
(c) |
|
Agency Securities are considered to have limited, if any, credit risk because the timely payment of principal and interest is guaranteed by Fannie Mae and Freddie Mac, which are federally chartered corporations, or Ginnie Mae, which is an agency of the federal government. Residential mortgage loans held by Capstead were originated prior to 1995 when the Company operated a mortgage conduit and the related credit risk is borne by the Company. Collateral for structured financings consists of private residential mortgage securities that are backed by loans obtained through this mortgage conduit and are pledged to secure repayment of related structured financings. Credit risk for these securities is borne by
-10-
the related bondholders. The maturity of Residential mortgage investments is directly affected by prepayments of principal on the underlying mortgage loans. Consequently, actual maturities will be significantly shorter than the portfolio’s weighted average contractual maturity of 292 months.
Fixed-rate investments consist of residential mortgage loans and Agency Securities backed by residential mortgage loans with fixed rates of interest. ARMs are adjustable-rate Agency 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, mortgage loans underlying ARM securities typically adjust either annually, semiannually, monthly, or over a rolling twelve month average, based on specified margins over an underlying market index, and are usually subject to periodic and lifetime limits, or caps, on the amount of such adjustments during any single interest rate adjustment period and over the contractual term of the underlying loans.
Capstead classifies its ARM investments based on average number of months until coupon reset (“months to roll”). Months to roll is an indicator of asset duration which is a measure of market price sensitivity to interest rate movements. A shorter duration generally indicates less interest rate risk. Current-reset ARM investments have months to roll of less than
In March 2020, the Company sold available-for-sale securities using the specific identification method for proceeds totaling $
NOTE 5 — SECURED borrowings
Capstead pledges its Residential mortgage investments as collateral for secured borrowings primarily in the form of repurchase arrangements with commercial banks and other financial institutions (collectively referred to as “counterparties” or “lending counterparties”). Repurchase arrangements entered into by the Company involve the sale and a simultaneous agreement to repurchase the transferred assets at a future date and are accounted for as financings. The Company maintains the beneficial interest in the specific securities pledged during the term of each repurchase arrangement and receives the related principal and interest payments.
The terms and conditions of secured borrowings are negotiated on a transaction-by-transaction basis when each such borrowing is initiated or renewed. The amount borrowed is generally equal to the fair value of the securities pledged, as determined by the lending counterparty, less an agreed-upon discount, referred to as a “haircut.” Interest rates are generally fixed based on prevailing rates corresponding to the terms of the borrowings. Interest may be paid monthly or at the termination of a borrowing at which time the
Company may enter into a new borrowing at prevailing haircuts and rates with the same lending counterparty or repay that counterparty and negotiate financing with a different lending counterparty. None of the Company’s lending counterparties are obligated to renew or otherwise enter into new borrowings at the conclusion of existing borrowings. In response to declines in fair value of pledged securities due to changes in market conditions or the publishing of monthly security pay-down factors, lending counterparties typically require the Company to post additional securities as collateral, pay down borrowings or fund cash margin accounts with the counterparties in order to re-establish the agreed-upon collateral requirements. These actions are referred to as margin calls. Conversely, in response to increases in fair value of pledged securities, the Company routinely margin calls its lending counterparties in order to have previously pledged collateral returned.
-11-
Secured borrowings (and related pledged collateral, including accrued interest receivable), classified by collateral type and remaining maturities, and related weighted average borrowing rates as of the indicated dates were as follows (dollars in thousands):
|
Collateral Type |
|
Agency Securities Pledged |
|
|
Accrued Interest Receivable |
|
|
Borrowings Outstanding |
|
|
Average Borrowing Rates |
|
||||
|
September 30, 2020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Borrowings under repurchase arrangements with maturities of 30 days or less |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
|
|
% |
|
Borrowings under repurchase arrangements with maturities of 31 to 90 days |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Borrowings under repurchase arrangements with maturities of greater than 90 days |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Similar borrowings secured by collateral for structured financings |
|
|
|
|
|
– |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Borrowings under repurchase arrangements with maturities of 30 days or less |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
|
|
% |
|
Borrowings under repurchase arrangements with maturities of 31 to 90 days |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Similar borrowings secured by collateral for structured financings |
|
|
|
|
|
– |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
Average secured borrowings outstanding were $
NOTE 6 — USE OF DERIVATIVES, OFFSETTING DISCLOSURES AND CHANGES IN OTHER COMPREHENSIVE INCOME BY COMPONENT
Capstead’s portfolio of derivative financial instruments (“Derivatives”) hedge the variability of the underlying benchmark interest rate of current and forecasted 30- to 90-day secured borrowings. The Company attempts to mitigate exposure to higher interest rates typically by entering into three-month London interbank offered rate (“LIBOR”) or OIS-indexed, pay-fixed, receive-variable, interest rate swap agreements for terms between
The Company discontinued hedge accounting in 2019 for its secured borrowings-related interest rate swaps and, for GAAP purposes, related changes in the fair value are recognized in the Company’s
-12-
consolidated statements of operations beginning on the de-designation date. Also, for GAAP purposes, related unrealized gains and losses recorded in Accumulated other comprehensive income through the de-designation date are being recognized as a component of interest expense in the Company’s Consolidated Statements of Operations over the remaining lives of these swaps.
During the quarter and nine months ended September 30, 2020, Capstead entered into swap agreements with notional amounts of $
|
Period of Contract Expiration |
|
Notional Amount |
|
|
Average Fixed-Rate Payment Requirement |
|
||
|
Third quarter 2021 |
|
$ |
|
|
|
|
|
% |
|
First quarter 2022 |
|
|
|
|
|
|
|
|
|
Second quarter 2022 |
|
|
|
|
|
|
|
|
|
Third quarter 2022 |
|
|
|
|
|
|
|
|
|
Third quarter 2023 |
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
|
|
|
Subsequent to September 30, 2020, the Company terminated $
The Company has three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements with notional amounts totaling $
Interest rate swap agreements are measured at fair value on a recurring basis primarily using Level 2 Inputs in accordance with ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820). Fair value estimates for these Derivatives are calculated using the net discounted future fixed cash payments and the discounted future variable cash receipts which are based on expected future interest rates derived from observable market interest rate curves. Eurodollar futures are measured at fair value using Level 1 inputs based on quoted exchange prices on these contracts. The Company also incorporates both its own nonperformance risk and its counterparties’ nonperformance risk in determining fair value. In considering the effect of nonperformance risk, the Company considered the impact of netting and credit enhancements, such as collateral postings and guarantees, and has concluded that counterparty risk is not significant to the overall valuation.
The fair value of exchange-traded swap agreements hedging Secured borrowings is calculated including accrued interest and net of variation margin amounts received or paid through the exchange, resulting in separately presenting on the balance sheet a significantly reduced fair value amount representing the unsettled fair value of these Derivatives. Non-exchange traded swap agreements held as cash flow hedges of Unsecured borrowings are reported at fair value calculated excluding accrued interest. Cash collateral receivable from derivative counterparties includes initial margin for all swap agreements and variation
-13-
margin for non-exchange traded swap agreements. Accrued interest for non-exchange traded swap agreements is included in Accounts payable and accrued expenses.
The following tables include fair value and other related disclosures regarding all Derivatives held as of and for the indicated periods (in thousands):
|
|
|
Balance Sheet |
|
September 30 |
|
|
December 31 |
|
||
|
|
|
Location |
|
2020 |
|
|
2019 |
|
||
|
Balance sheet-related |
|
|
|
|
|
|
|
|
|
|
|
Swap agreements in a gain position (an asset) related to secured borrowings |
|
(a) |
|
$ |
– |
|
|
$ |
|
|
|
Eurodollar futures contracts in a gain position |
|
(a) |
|
– |
|
|
|
|
|
|
|
Swap agreements in a loss position (a liability) related to |
|
|
|
|
|
|
|
|
|
|
|
unsecured borrowings |
|
(a) |
|
|
( |
) |
|
|
( |
) |
|
Related net interest payable |
|
(b) |
|
|
( |
) |
|
|
( |
) |
|
|
|
|
|
$ |
( |
) |
|
$ |
( |
) |
|
(a) |
|
|
(b) |
|
-14-
|
|
Location of Gain or (Loss) Recognized in |
|
Quarter Ended September 30 |
|
|
Nine Months Ended September 30 |
|
||||||||||
|
|
Net Income |
|
|
2020 |
|
|
|
2019 |
|
|
|
2020 |
|
|
|
2019 |
|
|
Income statement-related |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Components of Secured borrowings-related effects on interest expense: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount of gain reclassified from Accumulated other comprehensive income (loss) |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
– |
|
|
$ |
|
|
|
Amortization of unrealized gain, net of unrealized losses on de-designated Derivatives |
|
|
|
( |
) |
|
|
|
|
|
|
( |
) |
|
$ |
|
|
|
|
(a) |
|
|
( |
) |
|
|
|
|
|
|
( |
) |
|
|
|
|
|
Component of Unsecured borrowings-related effects on interest expense: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount of loss reclassified from Accumulated other comprehensive income (loss) |
(b) |
|
|
( |
) |
|
|
( |
) |
|
|
( |
) |
|
|
( |
) |
|
(Increase) decrease in interest expense as a result of the use of Derivatives |
|
|
$ |
( |
) |
|
$ |
|
|
|
$ |
( |
) |
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized and unrealized gain (loss) on non-designated Derivatives (net) related to: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap agreements |
|
|
$ |
|
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|
Eurodollar futures |
|
|
– |
|
|
|
|
|
|
|
( |
) |
|
|
|
|
|
|
|
(c) |
|
$ |
|
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income-related |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount of gain (loss) recognized in Other comprehensive income |
|
|
$ |
|
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|
(a) |
|
|
(b) |
Included in “Interest expense: Unsecured borrowings” on the face of the Consolidated Statements of Operations. |
|
(c) |
Included in “Loss on derivative instruments (net)” on the face of the Consolidated Statement of Operations. |
Capstead’s swap agreements and borrowings under repurchase arrangements are subject to master netting arrangements in the event of default on, or termination of, any one contract. See NOTE 5 for more information on the Company’s use of secured borrowings.
|
|
|
Offsetting of Derivative Assets |
|
|||||||||||||||||||||
|
|
|
|
|
|
|
Gross |
|
|
Net Amounts |
|
|
Gross Amounts Not Offset |
|
|
|
|
|
|||||||
|
|
|
Gross |
|
|
Amounts |
|
|
of Assets |
|
|
in the Balance Sheet (b) |
|
|
|
|
|
||||||||
|
|
|
Amounts of |
|
|
Offset in |
|
|
Presented in |
|
|
|
|
|
|
Cash |
|
|
|
|
|
||||
|
|
|
Recognized |
|
|
the Balance |
|
|
the Balance |
|
|
Financial |
|
|
Collateral |
|
|
Net |
|
||||||
|
|
|
Assets (a) |
|
|
Sheet (a) |
|
|
Sheet |
|
|
Instruments |
|
|
Received |
|
|
Amount |
|
||||||
|
September 30, 2020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Counterparty 4 |
|
$ |
|
|
|
$ |
( |
) |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
December 31, 2019 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Counterparty 4 |
|
$ |
|
|
|
$ |
( |
) |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
-15-
|
(a) |
|
|
(b) |
|
|
|
|
Offsetting of Financial Liabilities and Derivative Liabilities |
|
|||||||||||||||||||||
|
|
|
|
|
|
|
Gross |
|
|
Net Amounts |
|
|
Gross Amounts Not Offset |
|
|
|
|
|
|||||||
|
|
|
Gross |
|
|
Amounts |
|
|
of Liabilities |
|
|
in the Balance Sheet (c) |
|
|
|
|
|
||||||||
|
|
|
Amounts of |
|
|
Offset in |
|
|
Presented in |
|
|
|
|
|
|
Cash |
|
|
|
|
|
||||
|
|
|
Recognized |
|
|
the Balance |
|
|
the Balance |
|
|
Financial |
|
|
Collateral |
|
|
Net |
|
||||||
|
|
|
Liabilities (a) |
|
|
Sheet (a) |
|
|
Sheet (b) |
|
|
Instruments |
|
|
Pledged |
|
|
Amount |
|
||||||
|
September 30, 2020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives by counterparty: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Counterparty 1 |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
( |
) |
|
$ |
|
|
|
Counterparty 4 |
|
|
|
|
|
|
( |
) |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
( |
) |
|
|
|
|
|
|
|
|
|
( |
) |
|
|
|
||
|
Borrowings under repurchase arrangements (d) |
|
|
|
|
|
|
|
|
|
|
|
|
|
( |
) |
|
|
|
|
|
|
|||
|
|
|
$ |
|
|
|
$ |
( |
) |
|
$ |
|
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
|
|
|
December 31, 2019 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives by counterparty: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Counterparty 1 |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
( |
) |
|
$ |
|
|
|
Counterparty 4 |
|
|
|
|
|
|
( |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
|
|
|
|
|
|
|
( |
) |
|
|
|
|
|
|
|
|
|
|
( |
) |
|
|
|
|
|
Borrowings under repurchase arrangements (d) |
|
|
|
|
|
|
|
|
|
|
|
|
|
( |
) |
|
|
|
|
|
|
|||
|
|
|
$ |
|
|
|
$ |
( |
) |
|
$ |
|
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
|
|
|
(a) |
|
|
(b) |
Amounts presented are limited to recognized liabilities and cash collateral received associated with the indicated counterparty sufficient to reduce the related Net Amount to zero in accordance with ASU No. 2011-11, as amended by ASU No. 2013-01. |
|
(c) |
|
|
(d) |
|
-16-
The amount of unrealized losses, net of unrealized gains, included in Accumulated other comprehensive income (loss) and scheduled to be recognized in the Consolidated Statements of Operations over the next twelve months primarily in the form of a fixed-rate swap payments in excess of current market rates on swaps related to unsecured borrowings and amortization of net unrealized losses on de-designated interest rate swaps totaled $
|
|
|
Unrealized Gains and Losses on Cash Flow Hedges |
|
|
Unrealized Gains and Losses on Available-for-Sale Securities |
|
|
Total |
|
|||
|
Balance at June 30, 2020 |
|
$ |
( |
) |
|
$ |
|
|
|
$ |
|
|
|
Activity for the quarter ended September 30, 2020: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss before reclassifications |
|
|
|
|
|
|
( |
) |
|
|
( |
) |
|
Amounts reclassified from accumulated other comprehensive income (loss) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss (income) |
|
|
|
|
|
|
( |
) |
|
|
( |
) |
|
Balance at September 30, 2020 |
|
$ |
( |
) |
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2019 |
|
$ |
( |
) |
|
$ |
|
|
|
$ |
|
|
|
Activity for the nine months ended September 30, 2020: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss before reclassifications |
|
|
( |
) |
|
|
( |
) |
|
|
( |
) |
|
Amounts reclassified from accumulated other comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss |
|
|
( |
) |
|
|
|
|
|
|
|
|
|
Balance at September 30, 2020 |
|
$ |
( |
) |
|
$ |
|
|
|
$ |
|
|
NOTE 7 — unsecured BORROWINGS
Unsecured borrowings consist of
|
|
|
September 30, 2020 |
|
|
December 31, 2019 |
|
||||||||||
|
|
|
Borrowings Outstanding |
|
|
Average Rate |
|
|
Borrowings Outstanding |
|
|
Average Rate |
|
||||
|
Junior subordinated notes maturing in: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October 2035 ($35,000 face amount) |
|
$ |
|
|
|
|
|
% |
|
$ |
|
|
|
|
|
% |
|
December 2035 ($40,000 face amount) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 2036 ($25,000 face amount) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
|
|
|
|
$ |
|
|
|
|
|
|
-17-
NOTE 8 — CAPITAL TRANSACTIONS
In February 2020, the Company issued
NOTE 9 — FAIR VALUE
The fair value of Capstead’s financial assets and liabilities are influenced by changes in, and market expectations for changes in, interest rates and market liquidity conditions, as well as other factors beyond the control of management. With the exception of the fair value of Eurodollar futures, all fair values were determined using Level 2 Inputs in accordance with ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820). Eurodollar futures are derivative contracts for which Level 1 inputs are used to determine fair value.
Residential mortgage investments, nearly all of which are mortgage securities classified as available-for-sale, are measured at fair value on a recurring basis. In determining fair value estimates the Company considers recent trading activity for similar investments and pricing levels indicated by lenders in connection with designating collateral for secured borrowings, provided such pricing levels are considered indicative of actual market clearing transactions. In determining fair value estimates for Secured borrowings with initial terms of greater than
Fair value-related disclosures for financial instruments other than debt securities were as follows as of the indicated dates (in thousands):
|
|
|
|
September 30, 2020 |
|
|
December 31, 2019 |
|
||||||||||
|
|
Fair Value Hierarchy |
|
Carrying Amount |
|
|
Fair Value |
|
|
Carrying Amount |
|
|
Fair Value |
|
||||
|
Financial assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage loans |
Level 2 |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
Secured borrowings-related interest rate swap agreements |
Level 2 |
|
– |
|
|
– |
|
|
|
|
|
|
|
|
|
||
|
Eurodollar futures contracts |
Level 1 |
|
– |
|
|
– |
|
|
|
|
|
|
|
|
|
||
|
Financial liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured borrowings with initial terms of greater than 120 days |
Level 2 |
|
|
|
|
|
|
|
|
|
– |
|
|
– |
|
||
|
Unsecured borrowings |
Level 2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unsecured borrowings-related interest rate swap agreements |
Level 2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-18-
Fair value-related disclosures for debt securities were as follows as of the indicated dates (in thousands):
|
|
|
Amortized |
|
|
Gross Unrealized |
|
|
|
|
|
||||||
|
|
|
Cost Basis |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
||||
|
September 30, 2020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities classified as available-for-sale: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae/Freddie Mac |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
Ginnie Mae |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage securities classified as held-to-maturity |
|
|
|
|
|
|
|
|
|
– |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency Securities classified as available-for-sale: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae/Freddie Mac |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ginnie Mae |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage securities classified as held-to-maturity |
|
|
|
|
|
|
|
|
|
– |
|
|
|
|
|
|
|
|
|
September 30, 2020 |
|
|
December 31, 2019 |
|
||||||||||
|
|
|
Fair Value |
|
|
Unrealized Loss |
|
|
Fair Value |
|
|
Unrealized Loss |
|
||||
|
Securities in an unrealized loss position of one year or greater: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae/Freddie Mac |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
Ginnie Mae |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities in an unrealized loss position less than one year: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae/Freddie Mac |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ginnie Mae |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
From a credit risk perspective, federal government support for Fannie Mae and Freddie Mac helps ensure that fluctuations in value are due to interest rate changes and are not due to credit risk associated with these securities. The unrealized losses on the Company’s investment in ARM Agency Securities were caused by interest rate changes, and the contractual cash flows of those investments are guaranteed by an agency of the U.S. government. The Company does not intend to sell the investments as of September 30, 2020 and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases.
NOTE 10 — EQUITY INCENTIVE PLAN
All equity-based awards and other long-term incentive awards are made pursuant to the Company’s Amended and Restated 2014 Flexible Incentive Plan that was approved by stockholders in May 2014. At September 30, 2020, this plan had
-19-
Long-term Equity-based Awards – Performance-based Restricted Stock Units (“RSUs”)
RSU activity and related information for the nine months ended September 30, 2020 is summarized below:
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
Average |
|
|
|
|
|
Number of |
|
|
Grant Date |
|
||
|
|
|
Shares |
|
|
Fair Value |
|
||
|
Unvested RSU awards outstanding at December 31, 2019 |
|
|
|
|
|
$ |
|
|
|
Grants |
|
|
|
|
|
|
|
|
|
Forfeitures |
|
|
( |
) |
|
|
|
|
|
Unvested RSU awards outstanding at September 30, 2020 |
|
|
|
|
|
|
|
|
During the quarter and nine months ended September 30, 2020, the Company recognized in Compensation-related expense $
Dividends accrue from the date of grant and will be paid in cash to the extent the units convert into shares of common stock following completion of the related performance periods. If these shares do not vest, the related dividends will be forfeited. Included in Common stock dividends payable at September 30, 2020 are estimated dividends payable pertaining to these awards of $
Long-term Equity-based Awards – Restricted Stock Awards
Restricted stock award activity for the nine months ended September 30, 2020 is summarized below:
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
Average |
|
|
|
|
|
Number of |
|
|
Grant Date |
|
||
|
|
|
Shares |
|
|
Fair Value |
|
||
|
Unvested stock awards outstanding at December 31, 2019 |
|
|
|
|
|
$ |
|
|
|
Grants |
|
|
|
|
|
|
|
|
|
Vestings |
|
|
( |
) |
|
|
|
|
|
Unvested stock awards outstanding at September 30, 2020 |
|
|
|
|
|
|
|
|
During the quarter and nine months ended September 30, 2020, the Company recognized in Compensation-related expense $
Service-based stock awards issued to non-executive employees and to directors receive dividends on a current basis without risk of forfeiture if the related awards do not vest. Stock awards issued to executives defer the payment of dividends accruing between the grant dates and the end of related service periods. If these awards do not vest, the related accrued dividends will be forfeited. Included in Common stock dividend payable at September 30, 2020 are estimated dividends payable pertaining to these awards totaling $
-20-
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
Overview
Capstead operates as a self-managed REIT earning income from investing in a leveraged portfolio of residential mortgage pass-through securities consisting almost exclusively of short-duration ARM Agency Securities, which reset to more current interest rates within a relatively short period of time and are considered to have limited, if any, credit risk. See NOTE 1 to the consolidated financial statements (included under Item 1 of this report) for defined terms used in this discussion and analysis. By investing in short-duration ARM Agency Securities, the Company is positioned to benefit from future recoveries in financing spreads and experience smaller fluctuations in portfolio values compared to leveraged portfolios containing a significant amount of longer-duration fixed-rate mortgage securities. Duration is a common measure of market price sensitivity to interest rate movements. A shorter duration generally indicates less interest rate risk.
Capstead reported for GAAP purposes net income of $29 million, representing $0.25 per diluted common share for the quarter ended September 30, 2020. For the nine months ended September 30, 2020, the Company reported a net loss of $153 million, representing $(1.76) per diluted common share. The Company reported core earnings of $20 million and $62 million, respectively, or $0.16 and $0.49 per diluted common share for the quarter and nine months ended September 30, 2020. See “Reconciliation of GAAP and non-GAAP Financial Measures” for more information on core earnings. The GAAP loss for the nine months ended September 30, 2020 includes $161 million in losses on hedging-related derivatives due primarily to declining interest rates and $68 million in losses on the sale of $2.62 billion (basis) in ARM securities late in the first quarter. These sales, together with not replacing portfolio runoff in March and April helped ensure the Company had sufficient flexibility to meet future projected liquidity requirements while maintaining portfolio leverage at comfortable levels given disruptions experienced in the fixed income markets brought on by the novel coronavirus (“COVID-19”) pandemic.
The Company resumed replacing runoff in late April. GAAP and core earnings benefited from lower secured borrowings rates primarily due to a total of 150 basis points in reductions in the Fed Funds rate in March and favorable terms on new interest rate swap agreements entered into during the first nine months of the year. These benefits more than offset lower portfolio yields due to lower coupon interest rates on loans underlying the Company’s ARM Agency Securities, higher mortgage prepayment levels as well as changes in lifetime prepayment estimates. Historically low interest rates have led to exceedingly high prepayment speeds across all mortgage products. The Company expects prepayment speeds will remain elevated due to the interest rate market for the remainder of 2020 partially offset by the seasonal impacts of the conclusion of the housing market summer selling season.
Capstead finances its residential mortgage investments by leveraging its long-term investment capital with secured borrowings consisting primarily of borrowings under repurchase arrangements with commercial banks and other financial institutions. Long-term investment capital declined $160 million during the first nine months of 2020 to $1.01 billion at September 30, 2020, consisting of $663 million of common and $251 million of preferred stockholders’ equity (recorded amounts), together with $98 million of unsecured borrowings maturing in 2035 and 2036.
Capstead’s residential mortgage portfolio decreased $2.95 billion during the first nine months of 2020 to $8.27 billion at September 30, 2020. Secured borrowings decreased $2.63 billion to $7.64 billion as a result of lower portfolio balances. Portfolio leverage (secured borrowings divided by long-term investment capital) decreased to 7.55 to one at September 30, 2020 from 8.77 to one at December 31,
-21-
2019. Management continuously evaluates portfolio leverage levels in light of changes in market conditions.
COVID-19
An unprecedented, near-total shutdown of the U.S. economy beginning in March due to the COVID-19 pandemic heightened fears of extremely high credit default levels and recession, leading to de-risking occurring at all levels of the fixed income markets. Credit asset pricing came under severe pressure destabilizing fixed income markets and leading to lender margin calls, feeding additional selling as levered and even unlevered investors across the spectrum were forced to sell their most liquid positions to raise cash to meet additional margin calls and/or fund redemptions. Investors were already coming under stress due to declining Treasury rates which led to losses on derivatives held for hedging purposes and variation (valuation-based) margin calls. As the crisis deepened this additional drain on liquidity became more pronounced and included increased initial (base haircut) margin requirements for derivatives due to heightened market volatility. The result at the end of March was sharply falling asset prices even as market interest rates declined. During this period of extreme volatility, Capstead met all of its funding requirements and maintained sufficient flexibility to meet its liquidity requirements.
Intervention by the Federal Reserve in the form of the buying of fixed-rate Agency Securities since late March helped stabilize this key market sector leading to improved pricing levels for fixed-rate Agency Securities. While the Federal Reserve has not purchased ARM Agency Securities specifically, these actions also contributed to a more stable operating environment for Capstead, leading to improved pricing levels for ARM Agency Securities.
The Company’s potential liquidity at September 30, 2020 was $490 million and it believes it has ample access to necessary financing through its existing lending counterparties to meet its liquidity needs. See “Utilization of Long-term Investment Capital and Potential Liquidity” for further discussion.
The Company continues to operate portions of its business continuity plan and has not experienced any operational disruption due to its small number of employees who are all able to work remotely. Management will continue to closely monitor the situation and adapt its response as necessary to avoid any operational disruptions.
Recent Common Equity Issuances
During February 2020, Capstead issued 1.6 million shares of common stock through an at-the-market continuous offering program at an average issue price of $8.21, net of fees and other costs, for net proceeds of $12.9 million. Additional amounts of equity capital may be raised in the future under continuous offering programs or by other means, subject to market conditions, compliance with federal securities laws and blackout periods.
Book Value per Common Share
Book value per share (total stockholders’ equity, less liquidation preferences for outstanding shares of preferred stock, divided by outstanding shares of common stock) as of September 30, 2020 was $6.80 per share, an increase of $0.01 per share from June 30, 2020 book value of $6.79 per share. Derivative-related increases in value totaling $0.13 were offset by $0.13 in portfolio-related declines. Book value declined $1.82 from $8.62 as of December 31, 2019 primarily due to derivative-related declines in value throughout the nine months.
-22-
All but $1 million of Capstead’s residential mortgage investments portfolio and all of its derivatives are recorded at fair value on the Company’s balance sheet and are therefore included in the calculation of book value per common share. None of the Company’s borrowings are recorded at fair value. See NOTE 9 to the consolidated financial statements (included under Item 1 of this report) for additional disclosures regarding fair values of financial instruments held or issued by the Company.
Fair value is impacted by market conditions, including changes in interest rates, and the availability of financing at reasonable rates and leverage levels, among other factors. The Company’s investment strategy attempts to mitigate these risks by focusing on investments in Agency Securities, which are considered to have little, if any, credit risk and are collateralized by ARM loans with interest rates that reset periodically to more current levels, generally within five years. Because of these characteristics, the fair value of the Company’s portfolio is considerably 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 securities or longer-duration ARM and/or fixed-rate Agency Securities.
Residential Mortgage Investments
The following table illustrates Capstead’s portfolio of residential mortgage investments for the quarter and nine months ended September 30, 2020 (dollars in thousands):
|
|
|
Quarter Ended |
|
|
Nine Months Ended |
|
||
|
|
|
September 30, 2020 |
|
|
September 30, 2020 |
|
||
|
Residential mortgage investments, beginning of period |
|
$ |
8,327,900 |
|
|
$ |
11,222,182 |
|
|
Portfolio acquisitions (principal amount) |
|
|
980,740 |
|
|
|
2,389,333 |
|
|
Investment premiums on acquisitions |
|
|
40,333 |
|
|
|
84,902 |
|
|
Portfolio runoff (principal amount) |
|
|
(1,041,845 |
) |
|
|
(2,798,666 |
) |
|
Sales of investments (basis) |
|
|
– |
|
|
|
(2,620,297 |
) |
|
Investment premium amortization |
|
|
(20,056 |
) |
|
|
(56,135 |
) |
|
(Decrease) increase in net unrealized gains on securities classified as available-for-sale |
|
|
(12,563 |
) |
|
|
53,190 |
|
|
Residential mortgage investments, end of period |
|
$ |
8,274,509 |
|
|
$ |
8,274,509 |
|
|
Decrease in residential mortgage investments during the indicated periods |
|
$ |
(53,391 |
) |
|
$ |
(2,947,673 |
) |
Capstead’s investment strategy focuses on managing a portfolio of residential mortgage investments consisting almost exclusively of ARM Agency Securities. Agency Securities are considered to have limited, if any, credit risk because the timely payment of principal and interest is guaranteed by Fannie Mae and Freddie Mac, which are federally chartered corporations, or Ginnie Mae, which is an agency of the federal government. Federal government support for Fannie Mae and Freddie Mac has largely alleviated market concerns regarding the ability of Fannie Mae and Freddie Mac to fulfill their guarantee obligations.
By focusing on investing in short-duration ARM Agency Securities, changes in fair value caused by changes in interest rates are typically relatively modest compared to changes in fair value of longer-duration ARM or fixed-rate assets. This investment strategy positions the Company to benefit from potential recoveries in financing spreads.
-23-
Capstead classifies its ARM securities based on the average length of time until the loans underlying each security reset to more current rates (“months-to-roll”) (less than 18 months for “current-reset” ARM securities, and 18 months or greater for “longer-to-reset” ARM securities). The Company’s ARM holdings featured the following characteristics at September 30, 2020 (dollars in thousands):
|
ARM Type |
|
Amortized Cost Basis (a) |
|
Net WAC (b) |
|
Fully Indexed WAC (b) |
|
Average Net Margins (b) |
|
Average Periodic Caps (b) |
|
Average Lifetime Caps (b) |
|
Months To Roll |
|
Current-reset ARMs: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae Agency Securities |
$ |
2,130,244 |
|
2.80 |
% |
2.09 |
% |
1.65 |
% |
2.81 |
% |
6.63 |
% |
5.7 |
|
Freddie Mac Agency Securities |
|
689,436 |
|
3.00 |
|
2.15 |
|
1.77 |
|
2.26 |
|
5.80 |
|
7.0 |
|
Ginnie Mae Agency Securities |
|
188,406 |
|
3.00 |
|
1.64 |
|
1.51 |
|
1.09 |
|
5.48 |
|
6.1 |
|
Residential mortgage loans |
|
398 |
|
4.16 |
|
4.69 |
|
2.10 |
|
1.77 |
|
11.24 |
|
6.0 |
|
(37% of total) |
|
3,008,484 |
|
2.86 |
|
2.07 |
|
1.67 |
|
2.58 |
|
6.37 |
|
6.0 |
|
Longer-to-reset ARMs: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fannie Mae Agency Securities |
|
2,676,541 |
|
2.94 |
|
2.04 |
|
1.60 |
|
4.14 |
|
5.02 |
|
53.3 |
|
Freddie Mac Agency Securities |
|
1,958,282 |
|
2.75 |
|
2.10 |
|
1.66 |
|
4.29 |
|
5.02 |
|
60.8 |
|
Ginnie Mae Agency Securities |
|
531,767 |
|
3.65 |
|
1.62 |
|
1.50 |
|
1.00 |
|
5.00 |
|
41.5 |
|
(63% of total) |
|
5,166,590 |
|
2.94 |
|
2.02 |
|
1.61 |
|
3.87 |
|
5.02 |
|
54.9 |
|
|
$ |
8,175,074 |
|
2.91 |
|
2.04 |
|
1.63 |
|
3.40 |
|
5.52 |
|
37.0 |
|
Gross WAC (rate paid by borrowers) (c) |
|
|
|
3.54 |
|
|
|
|
|
|
|
|
|
|
|
(a) |
Amortized cost basis represents the Company’s investment (unpaid principal balance plus unamortized investment premiums) before unrealized gains and losses. At September 30, 2020, the ratio of amortized cost basis to unpaid principal balance for the Company’s ARM holdings was 103.35. This table excludes approximately $979,000 in fixed-rate agency-guaranteed mortgage pass-through securities, residential mortgage loans and private residential mortgage pass-through securities held as collateral for structured financings. |
|
(b) |
Net WAC, or weighted average coupon, is the weighted average interest rate of the mortgage loans underlying the indicated investments, net of servicing and other fees as of the indicated date. Net WAC is expressed as a percentage calculated on an annualized basis on the unpaid principal balances of the mortgage loans underlying these investments. As such, it is similar to the cash yield on the portfolio which is calculated using amortized cost basis. Fully indexed WAC represents the weighted average coupon upon one or more resets using interest rate indexes and net margins as of the indicated date. Average net margins represent the weighted average levels over the underlying indexes that the portfolio can adjust to upon reset, usually subject to initial, periodic and/or lifetime caps on the amount of such adjustments during any single interest rate adjustment period and over the contractual term of the underlying loans. |
|
(c) |
ARM securities with initial fixed-rate periods of five years or longer typically have either 200 or 500 basis point initial caps (and floors) with 200 basis point periodic caps (and floors). Additionally, certain ARM securities held by the Company are subject only to lifetime caps or are not subject to a cap. Nearly all ARM securities held by the Company have lifetime floors equal to their net margins. For presentation purposes, average periodic caps in the table above reflect initial caps until after an ARM security has reached its initial reset date and lifetime caps, less the current net WAC, for ARM securities subject only to lifetime caps. At quarter-end, 73% of current-reset ARMs were subject to periodic caps averaging 1.90%; 18% were subject to initial caps averaging 3.05%; and 9% were subject to lifetime caps averaging 7.37%. All longer-to-reset ARM securities at September 30, 2020 were subject to initial caps. |
|
(d) |
Gross WAC is the weighted average interest rate of the mortgage loans underlying the indicated investments, including servicing and other fees paid by borrowers, as of the indicated balance sheet date. |
Approximately 18%, or $533 million of the Company’s current-reset ARM securities with average net WACs of 2.69% and fully-indexed WACs of 2.06% will reset in rate for the first time in less than 18 months based on indices in effect at September 30, 2020. After consideration of any applicable initial fixed-rate periods, at September 30, 2020 approximately 91%, 5% and 3% of the Company’s ARM securities were backed by mortgage loans that reset annually, semi-annually and monthly, respectively, while approximately 1% reset every five years. Approximately 2% of the Company’s ARM securities were backed by interest-only loans, with remaining interest-only payment periods averaging 13 months at September 30, 2020. All percentages are based on averages of the characteristics of mortgage loans underlying each security and calculated using unpaid principal balances as of the indicated date.
-24-
Secured Borrowings and Related Derivatives Held for Hedging Purposes
Capstead finances its residential mortgage investments by leveraging its long-term investment capital with secured borrowings consisting primarily of borrowings under repurchase arrangements with commercial banks and other financial institutions that involve the sale and a simultaneous agreement to repurchase the transferred assets at a future date and are accounted for as financings. The Company maintains the beneficial interest in the specific securities pledged during the term of each repurchase arrangement and receives the related principal and interest payments.
The terms and conditions of secured borrowings are negotiated on a transaction-by-transaction basis when each such borrowing is initiated or renewed. None of the Company’s counterparties are obligated to renew or otherwise enter into new borrowings at the conclusion of existing borrowings. Collateral requirements in excess of amounts borrowed (referred to as “haircuts”) averaged 4.46 percent of the fair value of pledged residential mortgage pass-through securities at September 30, 2020, relatively consistent with prior year. After considering haircuts and related interest receivable on the collateral, as well as interest payable on these borrowings, the Company had $433 million of capital at risk with its lending counterparties at September 30, 2020. The Company did not have capital at risk with any single counterparty exceeding 6% of total stockholders’ equity at September 30, 2020.
Secured borrowing rates are generally fixed based on prevailing rates corresponding to the terms of the borrowings. Interest may be paid monthly or at the termination of a borrowing at which time the Company may enter into a new borrowing at prevailing haircuts and rates with the same counterparty or repay that counterparty and negotiate financing with a different counterparty. When the fair value of pledged securities declines due to changes in market conditions or the publishing of monthly security pay-down factors, lenders typically require the Company to post additional securities as collateral, pay down borrowings or fund cash margin accounts with the counterparties in order to re-establish the agreed-upon collateral requirements, referred to as margin calls. Conversely, if collateral fair values increase, lenders are required to release collateral back to the Company pursuant to Company-issued margin calls.
As of September 30, 2020, the Company’s secured borrowings totaled $7.64 billion with 19 counterparties at average rates of 0.24%, before the effects of currently-paying interest rate swap agreements. The Company typically uses interest rate swap agreements with terms between 18 and 36 months and variable rate receipts based on three-month LIBOR or OIS to help mitigate exposure to rising short-term interest rates. During the first nine months of 2020, the Company decreased its swap positions by $3.40 billion notional amount. At quarter-end the Company held $4.00 billion notional amount of these derivatives at fixed rates averaging 0.69% with contract expirations occurring at various dates through the third quarter of 2023 and a weighted average expiration of 16 months.
Including the effects of these derivatives, the Company’s residential mortgage investments and secured borrowings had estimated durations at September 30, 2020 of 14 months and 10 months, respectively for a net duration gap of approximately four months – see “Interest Rate Risk” for further information about the Company’s sensitivity to changes in market interest rates. The Company intends to continue to manage interest rate risk associated with holding and financing its residential mortgage investments by utilizing suitable derivatives such as interest rate swap agreements, Eurodollar futures and longer-maturity secured borrowings, if available at attractive rates and terms.
-25-
Utilization of Long-term Investment Capital and Potential Liquidity
Capstead’s investment strategy involves managing an appropriately leveraged portfolio of ARM Agency Securities that management believes can produce attractive risk-adjusted returns over the long term, while reducing, but not eliminating, sensitivity to changes in interest rates. The potential liquidity inherent in the Company’s unencumbered residential mortgage investments is as important as the actual level of cash and cash equivalents carried on the balance sheet because secured borrowings generally can be increased or decreased on a daily basis to meet cash flow requirements and otherwise manage capital resources efficiently. Potential liquidity is affected by, among other factors:
|
|
• |
current portfolio leverage levels, |
|
|
• |
changes in market value of assets pledged and derivatives held for hedging purposes as determined by lending and swap counterparties, |
|
|
• |
mortgage prepayment levels, |
|
|
• |
collateral requirements of lending and derivative counterparties, and |
|
|
• |
general conditions in the commercial banking and mortgage finance industries. |
Capstead’s utilization of its long-term investment capital and its estimated potential liquidity were as follows as of September 30, 2020 in comparison with December 31, 2019 (dollars in thousands):
|
|
|
Investments (a) |
|
|
Secured Borrowings |
|
|
Capital Employed |
|
|
Potential Liquidity (b) |
|
|
Portfolio Leverage |
||||
|
Residential mortgage investments |
|
$ |
8,274,509 |
|
|
$ |
7,644,830 |
|
|
$ |
629,679 |
|
|
$ |
260,210 |
|
|
|
|
Cash collateral receivable from derivative counterparties, net (c) |
|
|
|
|
|
|
|
|
|
|
46,800 |
|
|
– |
|
|
|
|
|
Other assets, net of other liabilities |
|
|
|
|
|
|
|
|
|
|
335,818 |
|
|
|
229,788 |
|
|
|
|
Balances as of September 30, 2020: |
|
$ |
8,274,509 |
|
|
$ |
7,644,830 |
|
|
$ |
1,012,297 |
|
|
$ |
489,998 |
|
|
7.55:1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances as of December 31, 2019 |
|
$ |
11,222,182 |
|
|
$ |
10,275,413 |
|
|
$ |
1,172,125 |
|
|
$ |
537,134 |
|
|
8.77:1 |
|
(a) |
Investments are stated at balance sheet carrying amounts, which generally reflect estimated fair value as of the indicated dates. |
|
(b) |
Potential liquidity is based on maximum amounts of borrowings available under existing uncommitted financing arrangements considering management’s estimate of the fair value of residential mortgage investments held as of the indicated dates adjusted for other sources of liquidity such as cash and cash equivalents and cash collateral pledged to secured borrowing counterparties. |
|
(c) |
Cash collateral receivable from derivative counterparties is presented net of cash collateral payable to derivative counterparties, if applicable, and the fair value of interest rate swap positions as of the indicated date. |
In order to efficiently manage its liquidity and capital resources, Capstead attempts to maintain sufficient liquidity reserves to fund borrowing and derivative margin calls under stressed market conditions, including margin calls resulting from monthly principal payments (remitted to the Company 20 to 45 days after any given month-end), as well as reasonably possible declines in the market value of pledged assets and derivative positions. Should market conditions deteriorate, management may reduce portfolio leverage and increase liquidity by raising new equity capital, selling mortgage securities and/or curtailing the replacement of portfolio runoff. Additionally, the Company routinely does business with a large number of lending counterparties, which bolsters financial flexibility to address challenging market conditions and limits exposure to any individual counterparty.
In response to significant declines in longer-term interest rates experienced earlier in 2020, the Company reduced portfolio leverage by only replacing a portion of portfolio runoff, selling assets and by taking a measured approach to deploying new common equity capital raised in February. The Company expects in the near-term for leverage to remain at or near these levels given current market conditions. Future levels of portfolio leverage will be dependent on many factors, including the size and composition of the Company’s investment portfolio (see “Liquidity and Capital Resources”).
-26-
Reconciliation of GAAP and 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 provide investors management’s view of the Company’s economic performance. 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:
|
|
Quarter Ended September 30 |
|
|
Nine Months Ended September 30 |
|
||||||||||||||||||||||||||
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||||||||||||||||||
|
|
Amount |
|
|
Per Share |
|
|
Amount |
|
|
Per Share |
|
|
Amount |
|
|
Per Share |
|
|
Amount |
|
|
Per Share |
|
||||||||
|
Net income (loss) |
$ |
29,082 |
|
|
$ |
0.25 |
|
|
$ |
3,196 |
|
|
$ |
(0.02 |
) |
|
$ |
(152,867 |
) |
|
$ |
(1.76 |
) |
|
$ |
(68,010 |
) |
|
$ |
(0.95 |
) |
|
Unrealized (gain) loss on non-designated derivative instruments |
|
(35,419 |
) |
|
|
(0.37 |
) |
|
|
(16,952 |
) |
|
|
(0.19 |
) |
|
|
18,535 |
|
|
|
0.20 |
|
|
|
68,673 |
|
|
|
0.79 |
|
|
Realized loss (net) on termination of derivative instruments |
|
26,187 |
|
|
|
0.28 |
|
|
|
31,673 |
|
|
|
0.35 |
|
|
|
128,071 |
|
|
|
1.34 |
|
|
|
55,875 |
|
|
|
0.64 |
|
|
Amortization of unrealized gain, net of unrealized losses on de-designated derivative instruments |
|
18 |
|
|
|
0.00 |
|
|
|
(3,119 |
) |
|
|
(0.03 |
) |
|
|
37 |
|
|
|
0.00 |
|
|
|
(12,854 |
) |
|
|
(0.15 |
) |
|
Realized loss on sale of investments |
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
67,820 |
|
|
|
0.71 |
|
|
|
1,365 |
|
|
|
0.02 |
|
|
Core earnings |
$ |
19,868 |
|
|
$ |
0.16 |
|
|
$ |
14,798 |
|
|
$ |
0.11 |
|
|
$ |
61,596 |
|
|
$ |
0.49 |
|
|
$ |
45,049 |
|
|
$ |
0.35 |
|
Management believes that presenting financing spreads on residential mortgage investments, a non-GAAP financial measure, provides useful information for evaluating the performance of the Company’s portfolio as opposed to total financing spreads because the non-GAAP measure speaks specifically to the performance of the Company’s investment portfolio. The following reconciles these measures for the indicated periods:
|
|
|
Quarter Ended September 30 |
|
|
Nine Months Ended September 30 |
|
||||||||||||
|
|
|
2020 |
|
|
|
2019 |
|
|
2020 |
|
|
|
2019 |
|
||||
|
Total financing spreads |
|
|
1.47 |
% |
|
|
|
0.31 |
% |
|
|
1.16 |
% |
|
|
|
0.35 |
% |
|
Impact of yields on other interest-earning assets (a) |
|
|
0.03 |
|
|
|
|
0.00 |
|
|
|
0.02 |
|
|
|
|
0.01 |
|
|
Impact of borrowing rates on other interest-paying liabilities (a) |
|
|
0.10 |
|
|
|
|
0.05 |
|
|
|
0.08 |
|
|
|
|
0.05 |
|
|
Impact of amortization of unrealized gain, net of unrealized losses on de-designated Derivatives |
|
|
0.00 |
|
|
|
|
(0.12 |
) |
|
|
0.00 |
|
|
|
|
(0.16 |
) |
|
Impact of net interest cash flows on non-designated Derivatives |
|
|
(0.42 |
) |
|
|
|
0.21 |
|
|
|
(0.23 |
) |
|
|
|
0.23 |
|
|
Financing spreads on residential mortgage investments |
|
|
1.18 |
|
|
|
|
0.45 |
|
|
|
1.03 |
|
|
|
|
0.48 |
|
|
(a) |
Other interest-earning assets consist of overnight investments and cash collateral receivable from derivative counterparties. Other interest-paying liabilities consist of unsecured borrowings and, at times, cash collateral payable to interest rate swap counterparties. |
-27-
RESULTS OF OPERATIONS
|
|
|
Quarter Ended |
|
|
Nine Months Ended |
|
||||||||||
|
|
|
September 30 |
|
|
September 30 |
|
||||||||||
|
|
|
2020 |
|
|
2019 |
|
|
2020 |
|
|
2019 |
|
||||
|
Income statement data: (in thousands, except per share data) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income on residential mortgage investments |
|
$ |
37,592 |
|
|
$ |
77,693 |
|
|
$ |
154,953 |
|
|
$ |
246,600 |
|
|
Related interest expense |
|
|
(4,824 |
) |
|
|
(62,800 |
) |
|
|
(63,152 |
) |
|
|
(194,524 |
) |
|
|
|
|
32,768 |
|
|
|
14,893 |
|
|
|
91,801 |
|
|
|
52,076 |
|
|
Other interest income (expense) |
|
|
(1,890 |
) |
|
|
(845 |
) |
|
|
(5,269 |
) |
|
|
(3,614 |
) |
|
|
|
|
30,878 |
|
|
|
14,048 |
|
|
|
86,532 |
|
|
|
48,462 |
|
|
Other expense: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain (loss) on derivative instruments (net) |
|
|
1,510 |
|
|
|
(9,221 |
) |
|
|
(161,177 |
) |
|
|
(105,720 |
) |
|
Loss on sale of investments (net) |
|
|
– |
|
|
|
– |
|
|
|
(67,820 |
) |
|
|
(1,365 |
) |
|
Compensation-related expense |
|
|
(1,985 |
) |
|
|
(566 |
) |
|
|
(6,519 |
) |
|
|
(6,147 |
) |
|
Other general and administrative expense |
|
|
(1,321 |
) |
|
|
(1,123 |
) |
|
|
(3,742 |
) |
|
|
(3,389 |
) |
|
Miscellaneous other revenue (expense) |
|
|
– |
|
|
|
58 |
|
|
|
(141 |
) |
|
|
149 |
|
|
|
|
|
(1,796 |
) |
|
|
(10,852 |
) |
|
|
(239,399 |
) |
|
|
(116,472 |
) |
|
Net income (loss) |
|
$ |
29,082 |
|
|
$ |
3,196 |
|
|
$ |
(152,867 |
) |
|
$ |
(68,010 |
) |
|
Net income (loss) per diluted common share |
|
$ |
0.25 |
|
|
$ |
(0.02 |
) |
|
$ |
(1.76 |
) |
|
$ |
(0.95 |
) |
|
Average diluted shares outstanding |
|
|
96,024 |
|
|
|
90,945 |
|
|
|
95,418 |
|
|
|
86,946 |
|
|
Core earnings (a) |
|
$ |
19,868 |
|
|
$ |
14,798 |
|
|
$ |
61,596 |
|
|
$ |
45,049 |
|
|
Core earnings per diluted common share (a) |
|
|
0.16 |
|
|
|
0.11 |
|
|
|
0.49 |
|
|
|
0.35 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Key operating statistics: (dollars in millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average yields: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage investments |
|
|
1.85 |
% |
|
|
2.76 |
% |
|
|
2.25 |
% |
|
|
2.78 |
% |
|
Other interest-earning assets |
|
|
0.07 |
|
|
|
2.36 |
|
|
|
0.43 |
|
|
|
2.02 |
|
|
Total average yields |
|
|
1.82 |
|
|
|
2.75 |
|
|
|
2.23 |
|
|
|
2.77 |
|
|
Average borrowing rates: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured borrowings (a)(b) |
|
|
0.67 |
|
|
|
2.31 |
|
|
|
1.22 |
|
|
|
2.30 |
|
|
Unsecured borrowings |
|
|
7.76 |
|
|
|
7.77 |
|
|
|
7.74 |
|
|
|
7.69 |
|
|
Total average borrowing rates |
|
|
0.77 |
|
|
|
2.36 |
|
|
|
1.30 |
|
|
|
2.35 |
|
|
Average total financing spreads |
|
|
1.47 |
|
|
|
0.31 |
|
|
|
1.16 |
|
|
|
0.35 |
|
|
Average financing spreads on residential mortgage investments (a) |
|
|
1.18 |
|
|
|
0.45 |
|
|
|
1.03 |
|
|
|
0.48 |
|
|
Average CPR |
|
|
39.97 |
|
|
|
30.18 |
|
|
|
33.19 |
|
|
|
25.69 |
|
|
Average balance information: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage investments (cost basis) |
|
$ |
8,121 |
|
|
$ |
11,267 |
|
|
$ |
9,163 |
|
|
$ |
11,830 |
|
|
Other interest-earning assets |
|
|
125 |
|
|
|
180 |
|
|
|
138 |
|
|
|
113 |
|
|
Secured borrowings |
|
|
7,448 |
|
|
|
10,481 |
|
|
|
8,474 |
|
|
|
10,941 |
|
|
Unsecured borrowings (included in long-term investment capital) |
|
|
98 |
|
|
|
98 |
|
|
|
98 |
|
|
|
98 |
|
|
Long-term investment capital (“LTIC”) |
|
|
1,018 |
|
|
|
1,147 |
|
|
|
1,043 |
|
|
|
1,153 |
|
|
Operating costs as a percentage of average LTIC |
|
|
1.29 |
% |
|
|
0.58 |
% |
|
|
1.31 |
% |
|
|
1.11 |
% |
|
Return on average common equity capital (c) |
|
|
8.94 |
|
|
|
4.95 |
|
|
|
9.06 |
|
|
|
5.08 |
|
|
(a) |
See “Reconciliation of GAAP and non-GAAP Financing Measures” for a reconciliation of these financial measures and the Company’s rationale for using these non-GAAP financial measures. |
|
(b) |
Secured borrowing rates exclude the effects of amortization of the net unrealized gains and losses included in Accumulated other comprehensive income (loss) upon de-designation in 2019 of related derivatives held for hedging purposes and include net interest cash flows from that date on non-designated derivatives totaling (0.42)% and (0.23)% for the quarter and nine months ended September 30, 2020, respectively, to better compare the components of financing spreads on residential mortgage investments with prior periods. |
|
(c) |
Calculated using core earnings less preferred dividends on an annualized basis over average common equity for the period. |
|
-28-
Capstead reported for GAAP purposes net income of $29 million representing $0.25 per diluted common share for the quarter ended September 30, 2020. For the nine months ended September 30, 2020, the Company reported a net loss of $153 million, representing $(1.76) per diluted common share. This compares to a GAAP net income of $3 million and a net loss of $68 million or $(0.02) and $(0.95) per diluted common share for the same periods in 2019. GAAP net income was negatively impacted by losses on derivatives of $161 million due largely to lower prevailing interest rates and losses on sales of investments of $68 million due to COVID-19 pandemic related disruptions to the fixed income markets.
Capstead’s core earnings, a non-GAAP financial measure, totaled $20 million and $62 million or $0.16 and $0.49 per diluted common share for the quarter and nine months ended September 30, 2020, respectively, compared to core earnings of $15 million and $45 million or $0.11 and $0.35 per diluted common share for the same period in 2019. Core earnings in the first nine months of 2020 benefited from lower borrowing rates while being hampered by lower yields on residential mortgage investments and lower average portfolio balances following asset sales in response to the COVID-19 pandemic in late March.
Interest income on residential mortgage investments was lower by $40 million and $92 million for the quarter and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. This decrease is attributable to $18 million and $50 million, respectively, in decreases related to lower average portfolio balances and $22 million and $42 million, respectively, in decreases related to lower average yields.
Yields on residential mortgage investments for the quarter and nine months ended September 30, 2020 decreased 91 and 53 basis points compared to the same periods in 2019, averaging 1.85% and 2.25%, respectively, primarily due to lower coupon interest rates on loans underlying the Company’s ARM Agency Securities that have reset based on lower prevailing interest rates, as well as lower coupons on acquisitions and other changes in portfolio composition. Yields were also negatively impacted by higher premium amortization compared to the same periods in 2019 due primarily to higher prepayment rates experienced on the portfolio.
Historically low interest rates have led to exceedingly high prepayment speeds across all mortgage products. While ARM securities are priced to incur higher prepayment speeds than fixed rate securities, and fixed rate securities have incurred higher percentage increases than ARM securities over previous levels, the Company’s ARM securities have experienced elevated prepayment speeds ultimately hurting yields on its investments. The Company expects prepayment speeds will remain elevated due to the interest rate market for the remainder of 2020 partially offset by the seasonal impacts of the conclusion of the housing market summer selling season.
Interest expense on secured borrowings was lower by $58 million and $131 million for the quarter and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. This decrease is attributable to $44 million and $94 million, respectively, in decreases related to lower average borrowing rates and $14 million and $37 million, respectively, in decreases related to lower average borrowings.
Secured borrowing rates, after adjusting for hedging activities, decreased 164 and 108 basis points for the quarter and nine months ended September 30, 2020, respectively, compared to the same period in 2019 to average 0.67% and 1.22%. Market conditions contributed to lower borrowing rates, including 75 basis points in decreases to the Federal Funds rate during the last half of 2019 followed by 150 basis points in rate cuts in March 2020. Average fixed-rate swap payment rates were 95 and 137 basis points for the quarter and nine months ended September 30, 2020, respectively, compared to 214 and 212 basis points for the same periods in 2019. This decline was largely due to efforts to reposition the swap portfolio to take advantage of declining market interest rates over the course of 2019 and 2020 and a reduction in swap positions due to asset sales in March 2020. Currently-paying swap balances were lower, averaging
-29-
$4.02 billion and $5.16 billion for the quarter and nine months ended September 30, 2020, respectively, compared to $7.29 billion and $7.56 billion for the same periods in 2019. Future secured borrowing rates will be dependent on market conditions, including overall levels of market interest rates as well as the availability of longer-maturity borrowings and interest rate swap agreements at attractive rates.
Total operating costs, which include Compensation-related expense and Other general and administrative expense, were higher by $1.6 million and $725,000 during the quarter and nine months ended September 30, 2020, respectively, compared to the same period in 2019. The variance between the periods was primarily related to adjustments to short- and long-term incentive compensation in the respective periods.
liquidity and capital resources
Capstead’s primary sources of funds are secured borrowings and monthly principal and interest payments on its investments. Other sources of funds may include proceeds from debt and equity offerings and asset sales. The timing, manner, price and amount of any future common and preferred issuances and any common stock repurchases will be made in the open market at the Company’s discretion, subject to economic and market conditions, stock price, compliance with federal securities laws and tax regulations as well as blackout periods associated with the dissemination of important Company-specific news.
The Company generally uses its liquidity to pay down secured borrowings to reduce borrowing costs and otherwise efficiently manage its long-term investment capital. Because the level of these borrowings can generally be adjusted on a daily basis, the Company’s potential liquidity inherent in its unencumbered residential mortgage investments is as important as the level of cash and cash equivalents carried on the balance sheet. The table included under “Utilization of Long-term Investment Capital and Potential Liquidity” illustrates management’s estimate of additional funds potentially available to the Company at September 30, 2020. The discussion accompanying this table and under “COVID-19” provides insight into the Company’s current liquidity position and perspective on what level of portfolio leverage to employ under current market conditions. 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 the Company’s continued qualification as a REIT.
Capstead finances its residential mortgage investments primarily by borrowing under repurchase arrangements, the terms and conditions of which are negotiated on a transaction-by-transaction basis, when each such borrowing is initiated or renewed.
Future borrowings are dependent upon the willingness of lenders to participate in the financing of Agency Securities, lender collateral requirements and the lenders’ determination of the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates and liquidity conditions within the commercial banking and mortgage finance industries. None of the Company’s borrowing counterparties are obligated to renew or otherwise enter into new borrowings at the conclusion of existing borrowings. Secured borrowings totaled $7.64 billion at September 30, 2020 with $7.14 billion maturing within 90 days. Secured borrowings began the year at $10.28 billion and averaged $7.45 billion during the quarter ended September 30, 2020. Average secured borrowings can differ from period-end balances for a number of reasons including portfolio growth or contraction, as well as differences in the timing of portfolio acquisitions relative to portfolio runoff.
To help mitigate exposure to rising short-term interest rates, the Company uses derivatives supplemented with longer-maturity secured borrowings when available at attractive rates and terms. At quarter-end the Company held $4.00 billion notional amount of portfolio financing-related interest rate swap agreements with contract expirations occurring at various dates through the third quarter of 2023 and a weighted average expiration of 16 months. The Company also holds swap agreements effectively locking in lower fixed rates of interest during the 20-year floating rate terms of the Company’s $100 million face amount of unsecured borrowings that mature in 2035 and 2036. Secured borrowings with remaining maturities of
-30-
greater than six months totaled $500 million at quarter-end with a weighted average remaining maturity of 11 months. The Company intends to continue to utilize suitable derivatives such as interest rate swap agreements or other derivatives and longer-maturity secured borrowings to manage interest rate risk when available at attractive rates and terms.
During February 2020, Capstead issued 1.6 million shares of common stock through an at-the-market continuous offering program at an average issue price of $8.21, net of fees and other costs, for net proceeds of $12.9 million. Additional amounts of equity capital may be raised in the future under continuous offering programs or by other means, subject to market conditions, compliance with federal securities laws and blackout periods.
Interest Rate Risk
Because Capstead’s residential mortgage investments consist almost entirely of Agency Securities, which are considered to have limited, if any, credit risk, interest rate risk is the primary market risk faced by the Company. Interest rate risk is highly sensitive to a number of factors, including economic conditions, government fiscal policy, central bank monetary policy and banking regulation. By focusing on investing in relatively short-duration ARM Agency Securities, declines in fair value caused by increases in interest rates are typically relatively modest compared to investments in longer-duration ARM or fixed-rate assets. These declines can be recovered in a relatively short period of time as coupon interest rates on the underlying mortgage loans reset to rates more reflective of the then-current interest rate environment. This strategy also positions the Company to benefit from future recoveries in financing spreads that typically contract during periods of rising interest rates.
Derivatives and longer-maturity secured borrowings transactions lengthen the effective duration of the Company’s secured borrowings to more closely match the duration of its portfolio of residential mortgage investments. Including the effects of derivatives held to hedge changes in secured borrowing rates, at September 30, 2020 the Company’s residential mortgage investments and secured borrowings had estimated durations of approximately 14 months and 10 months, respectively, for a net duration gap of approximately four months. The Company intends to continue to manage interest rate risk associated with holding and financing its residential mortgage investments by utilizing suitable interest rate swap agreements or other derivatives and longer-maturity secured borrowings, if available at attractive rates and terms.
Capstead performs sensitivity analyses to estimate the effects that specific interest rate changes can reasonably be expected to have on net interest margins and portfolio values. All investments, secured borrowings and related derivatives held are included in these analyses. For net interest margin modeling purposes, the model incorporates management’s assumptions for mortgage prepayment levels for a given interest rate change using market-based estimates of prepayment speeds for the purpose of amortizing investment premiums and reinvesting portfolio runoff. These assumptions are developed through a combination of historical analysis and expectations for future pricing behavior under normal market conditions unaffected by changes in market liquidity. For portfolio valuation modeling purposes, a static portfolio is assumed.
This model is the primary tool used by management to assess the direction and magnitude of changes in net interest margins and portfolio values resulting solely from changes in interest rates. Key modeling assumptions include mortgage prepayment speeds, adequate levels of market liquidity, current market conditions, and portfolio leverage levels. A floor of 0.00% is assumed for all pertinent indices except the Federal Funds Rate, which has no floor. However, it is assumed that borrowing rates cannot decline beyond a floor of 0.15%. These assumptions are inherently uncertain and, as a result, modeling cannot precisely estimate the impact of higher or lower interest rates. Actual results will differ from simulated results due to the timing, magnitude and frequency of interest rate changes, other changes in market conditions, changes in management strategies and other factors.
-31-
The table below reflects the estimated impact of instantaneous parallel shifts in the yield curve on net interest margins and the fair value of Capstead’s portfolio of residential mortgage investments and related derivatives at September 30, 2020 and December 31, 2019, subject to the modeling parameters described above.
|
|
|
Federal Funds Rate |
|
10-year U.S. Treasury Rate |
|
|
Down 1.00% |
|
|
Down 0.50% |
|
|
Up 0.50% |
|
|
Up 1.00% |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Projected 12-month percentage change in net interest margins: (a)(b) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2020 |
|
0.00-0.25 |
% |
|
0.69 |
% |
|
|
(48.6 |
)% |
|
|
(17.5 |
)% |
|
|
(0.2 |
)% |
|
|
(2.9 |
)% |
|
December 31, 2019 |
|
1.50-1.75 |
|
|
1.92 |
|
|
|
1.6 |
|
|
|
1.2 |
|
|
|
(0.6 |
) |
|
|
(3.7 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Projected percentage change in portfolio and related derivative values: (a) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2020 |
|
0.00-0.25 |
|
|
0.69 |
|
|
|
0.0 |
|
|
|
0.1 |
|
|
|
(0.4 |
) |
|
|
(0.7 |
) |
|
December 31, 2019 |
|
1.50-1.75 |
|
|
1.92 |
|
|
|
(0.1 |
) |
|
|
0.0 |
|
|
|
(0.2 |
) |
|
|
(0.4 |
) |
|
(a) |
Sensitivity of net interest margins as well as portfolio and related derivative values to changes in interest rates is determined relative to the actual rates at the applicable date. Note that the projected 12-month net interest margin 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, if investments made will behave in the same fashion as assets currently held or if management will choose to replace runoff with such assets. |
|
(b) |
The change in the projected Down 1.00 and 0.50% scenarios at September 30, 2020 compared to December 31, 2019 primarily relates to the change in interest rate environment caused by the 150 basis point declines in the Federal Funds Rate in March 2020. The model assumes a floor on all pertinent market indices of 0.00% except the Federal Funds Rate, which has no floor. However, borrowing rates cannot decline below 0.15%. |
CRITICAL ACCOUNTING POLICIES
Management’s discussion and analysis of financial condition and results of operations is based upon Capstead’s 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 and book value per common share. Actual results may differ from these estimates under different assumptions or conditions.
Management believes the following are critical accounting policies in the preparation of Capstead’s consolidated financial statements that involve the use of estimates requiring considerable judgment:
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Amortization of investment premiums on residential mortgage investments – Investment premiums on residential mortgage investments are recognized in earnings as adjustments to interest income by the interest method over the estimated lives of the related assets. Amortization is affected by actual portfolio runoff (scheduled and unscheduled principal paydowns) and by estimates and judgments related to future levels of mortgage prepayments that may be necessary to achieve the required effective yield over the estimated life of the related investment. |
Mortgage prepayment expectations can change based on how current and projected changes in interest rates impact the economic attractiveness of mortgage refinance opportunities, if available, and
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other factors such as lending industry underwriting practices and capacity constraints, regulatory changes, borrower credit profiles and the health of the economy and housing markets. Management estimates future mortgage prepayments based on these factors and past experiences with specific investments within the portfolio. Should actual prepayment rates differ materially from these estimates, investment premiums would be expensed at a different pace.
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Fair value and impairment accounting for residential mortgage investments – Nearly all of Capstead’s residential mortgage investments are held in the form of mortgage securities that are classified as 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. Fair values fluctuate with current and projected changes in interest rates, prepayment expectations and other factors such as market liquidity conditions and the perceived credit quality of Agency Securities. Judgment is required to interpret market data and develop estimated fair values, particularly in circumstances of deteriorating credit quality and market liquidity. See NOTE 8 to the consolidated financial statements (included under Item 1 of this report) for discussion of how Capstead values its residential mortgage investments. |
Generally, gains or losses are recognized in earnings only if securities are sold; however, if a decline in fair value of a mortgage security below its amortized cost occurs, the difference between amortized cost and fair value would be recognized in earnings as a component of Other income (expense) if the decline was credit-related or it was determined to be more likely than not that the Company will incur a loss via an asset sale.
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Accounting for derivative instruments – Derivatives are recorded as assets or liabilities and carried at fair value. Fair values fluctuate with current and projected changes in interest rates and other factors such as the Company’s and its counterparties’ nonperformance risk. Judgment is required to develop estimated fair values. |
The accounting for changes in fair value of each derivative held depends on whether it has been designated as an accounting hedge, as well as the type of hedging relationship identified. To qualify as a cash flow hedge for accounting purposes, at the inception of the hedge relationship the Company must anticipate and document that the hedge relationship will be highly effective and must monitor ongoing effectiveness on at least a quarterly basis. As long as the hedge relationship remains highly effective, changes in fair value of the derivative are recorded in Accumulated other comprehensive income. Changes in fair value of derivatives not held as accounting hedges, or for which the hedge relationship is deemed to no longer be highly effective and as a result hedge accounting is terminated, are recorded in earnings as a component of Other income (expense).
The Company uses derivatives primarily in the form of interest rate swap agreements to hedge the variability in borrowing rates on its secured and unsecured borrowings. For derivatives designated as accounting hedges, fixed interest payments and variable interest receipts are recorded as an adjustment to interest expense on the related designated borrowings. For derivatives not designated as accounting hedges, fixed interest payments and variable interest receipts are recorded as a component of Other income (expense). For derivatives initially designated as an accounting hedge and subsequently de-designated, any unrealized gain or loss included in Accumulated other comprehensive income at the time of de-designation is amortized as an adjustment to interest expense on the related borrowings over the remaining term of the derivatives. See NOTE 6 to the consolidated financial statements (included under Item 1 of this report) and “Financial Condition – Secured Borrowings” for additional information regarding the Company’s current use of derivatives and its related risk management policies.
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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:
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fluctuations in interest rates and levels of mortgage prepayments; |
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changes in market conditions as a result of federal corporate and individual income tax reform, federal government fiscal challenges and Federal Reserve monetary policy, including policy regarding its holdings of Agency and U.S. Treasury Securities; |
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liquidity of secondary markets and credit markets, including the availability of financing at reasonable levels and terms to support investing on a leveraged basis; |
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the impact of differing levels of leverage employed; |
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changes in legislation or regulation affecting Agency Securities and similar federal government agencies and related guarantees; |
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deterioration in credit quality and ratings of existing or future issuances of Agency Securities; |
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the effectiveness of risk management strategies; |
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the availability of suitable qualifying investments from both an investment return and regulatory perspective; |
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the availability of new investment capital; |
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the ability to maintain real estate investment trust (“REIT”) status; |
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changes in legislation or regulation affecting exemptions for mortgage REITs from regulation under the Investment Company Act of 1940; |
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negative impacts from the ongoing novel coronavirus (COVID-19) pandemic including on the U.S. or global economy or on our liquidity, financial condition and earnings; |
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other changes in legislation or regulation affecting the mortgage and banking industries; and |
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changes in general economic conditions, increases in costs and other general competitive factors. |
In light of the ongoing COVID-19 pandemic, several of the risks and uncertainties described above are more likely to occur and/or the potential impact therefrom is harder to estimate. In particular, the impact of COVID-19 on fluctuations in interest rates and levels of mortgage prepayments, liquidity of secondary markets and credit markets, including the availability of financing at reasonable levels and terms to support investing on a leveraged basis, and changes in general economic conditions, are especially unclear at this time. Given this unprecedented uncertainty, actual results could differ materially from those anticipated or implied in the forward-looking statements included herein. 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.
For a further discussion of these and other factors that could impact our future results and performance, see “Risk Factors” under Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 21, 2020, as well as our subsequent filings with the SEC.
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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. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Item 4. Controls and Procedures
As of September 30, 2020, an evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of September 30, 2020. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to September 30, 2020.
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PART II. — OTHER INFORMATION
ITEM 1A. RISK FACTORS
There have been no material changes in our risk factors during the nine months ended September 30, 2020 from those previously disclosed in “Risk Factors” under Part I, Item 1A. of our 2019 Form 10-K and Part II, Item 1A. of our March 2020 Form 10-Q. You should carefully consider the risk factors discussed in our 2019 Form 10-K and March 2020 Form 10-Q, which could materially affect our business, liquidity, earnings, financial condition and future prospects. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, liquidity, earnings, financial condition and future prospects.
ITEM 6. EXHIBITS
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Exhibit Number |
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DESCRIPTION |
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Exhibit Number |
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DESCRIPTION |
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32.1 |
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Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002** |
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32.2 |
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Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002** |
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101.INS |
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Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.* |
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101.SCH |
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Inline XBRL Taxonomy Extension Schema* |
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101.CAL |
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Inline XBRL Taxonomy Extension Calculation Linkbase* |
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101.DEF |
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Inline XBRL Additional Taxonomy Extension Definition Linkbase* |
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101.LAB |
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Inline XBRL Taxonomy Extension Label Linkbase* |
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101.PRE |
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Inline XBRL Taxonomy Extension Presentation Linkbase* |
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104 |
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Cover Page Interactive Data File (embedded within the Inline XBRL document)* |
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(1) |
Incorporated by reference to the Registrant’s Annual Report on Form 10-K/A (No. 001-08896) for the year ended December 31, 2012. |
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(2) |
Incorporated by reference to the Registrant’s Registration of Certain Classes of Securities on Form 8-A (No. 001-08896) dated May 13, 2013. |
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(3) |
Incorporated by reference to the Registrant’s Current Report on Form 8-K (No. 001-08896), filed on February 3, 2014, for the event dated January 29, 2014. |
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(4) |
Incorporated by reference to the Registrant’s Registration Statement on Form S-3 (No. 333-63358) dated June 19, 2001. |
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(5) |
Incorporated by reference to the Registrant’s Annual Report on Form 10-K (No. 001-08896) for the year ended December 31, 2011. |
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(6) |
Incorporated by reference to the Registrant’s Annual Report on Form 10-K (No. 001-08896) for the year ended December 31, 2019. |
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(7) |
Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (No. 001-08896) for the quarter ended June 30, 2019 |
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(8) |
Incorporated by reference to the Registrant’s Current Report on Form 8-K (No. 001-08896), filed on May 30, 2014, for the event dated May 28, 2014. |
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(9) |
Incorporated by reference to the Registrant’s Current Report on Form 8-K (No. 001-08896), filed on February 20, 2015, for the event dated February 20, 2015. |
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(10) |
Incorporated by reference to the Registrant’s Current Report on Form 8-K (No. 001-08896), filed on January 4, 2018, for the event dated January 3, 2018. |
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(11) |
Incorporated by reference to the Registrant’s Current Report on Form 8-K (No. 001-08896), filed on January 7, 2019, for the event dated January 3, 2019. |
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(12) |
Incorporated by reference to the Registrant’s Current Report on Form 8-K (No.001-08896), filed on January 3, 2020, for the event dated January 2, 2020. |
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(13) |
Incorporated by reference to the Registrant’s Annual Report on Form 10-K (No. 001-08896) for the year ended December 31, 2017. |
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(14) |
Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q (No. 001-08896) for the quarter ended September 30, 2019. |
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* |
Filed herewith |
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** |
Furnished herewith |
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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.
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CAPSTEAD MORTGAGE CORPORATION Registrant |
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Date: November 3, 2020 |
By: |
/s/ PHILLIP A. REINSCH |
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Phillip A. Reinsch |
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President and Chief Executive Officer |
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Date: November 3, 2020 |
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By: |
/s/ LANCE J. PHILLIPS |
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Lance J. Phillips |
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Senior Vice President, Chief Financial Officer |
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and Secretary (Principal Financial and |
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Accounting Officer) |
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