Capstead Mortgage Management Discusses Q1 2013 Results - Earnings Call Transcript

Apr.26.13 | About: Capstead Mortgage (CMO)

Capstead Mortgage (NYSE:CMO)

Q1 2013 Earnings Call

April 25, 2013 9:00 am ET

Executives

Lindsey Crabbe

Andrew F. Jacobs - Chief Executive Officer, President and Director

Robert R. Spears - Executive Vice President and Director of Residential Mortgage Investments

Phillip A. Reinsch - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Secretary

Analysts

Joel Jerome Houck - Wells Fargo Securities, LLC, Research Division

Michael R. Widner - Keefe, Bruyette, & Woods, Inc., Research Division

Stephen Laws - Deutsche Bank AG, Research Division

Operator

Good morning, and welcome to the Capstead Mortgage First Quarter 2013 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Lindsey Crabbe. Please go ahead.

Lindsey Crabbe

Good morning, everyone. Thank you for attending Capstead's First Quarter 2013 Earnings Conference Call. The first quarter earnings press release was issued yesterday, April 24. The press release is posted on our website at www.capstead.com. The link to this webcast is in the Investor Relations section of our website, and an archive of this webcast will be available for 60 days. A replay of this call will be available through June 26. Details of the replay are included in yesterday's release. Starting off today's call is Andy Jacobs, our President and CEO.

Before we get started, I want to remind you that some of today's comments could be considered forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are based on certain assumptions and expectations of management. For a detailed list of all the risk factors associated with our business, please refer to our filings with the SEC, which are available on our website. The information contained in this call is current only as of the date of this call, April 25, 2013. The company assumes no obligation to update any statements, including any forward-looking statements made during this call.

With that, I'll turn the call over to Andy.

Andrew F. Jacobs

Well, good morning, and welcome to our earnings call. As usual, I'm joined by Robert Spears, our Portfolio Manager; and Phil Reinsch, our CFO. And they will be available after a few opening remarks by myself.

For the quarter, we released yesterday, I guess, after the close. We reported $34.9 million for the quarter, which was $0.31 per diluted common share. Our net interest margin for the quarter were $37.9 million, which was slightly smaller than the previous quarter. And we had a smaller portfolio on balance, so we did have a 2-basis-point improvement in our net financing spread to 115 basis points. Portfolio yields averaged 1.73%, which were 3 basis points lower than the fourth quarter, which reflected lower average coupon. I think an important element of it is the yield adjustments from premium amortization represented about 84 basis points during the first quarter, which was the same as it was in the fourth quarter. And this reflected pretty much relatively stable mortgage prepayments, which our CPR for the quarter was 19.65%.

I think the positive thing, I think, from the fourth quarter to the first quarter was our repo rate. We did see some more stability in repo rate. Our borrowing costs, including the effect of swaps, decreased 5 basis points to a total of 58 basis points. As I said, lower prevailing mortgage -- lower prevailing repo rates. And I think very important is that we replaced $1.1 billion in interest rate swaps that had run off. During the first quarter, there were 81 basis points, and they were replaced with 100 -- $1.1 billion in other swaps that the average rate was 50 basis points. So that contributed mightily to the improvement in our borrowing cost for the period. Operating cost as a percent of long-term investment capital declined to 77 basis points from 79 in the previous quarter.

Portfolio acquisitions during the quarter totaled about a little over $800 million. That's principal amount, while portfolio runoff totaled $810 million, so pretty much a push from what ran off and what we replaced. For the quarter, we ended the quarter at $13.9 billion portfolio. It was leveraged 8.06:1. Net duration gap was 1 month. And on an overall basis, we think -- as we've discussed in our press release, we think that the prepayment levels from here with what's going on, they will be manageable in coming quarters. And overall, I think as you saw, our book value did improve, albeit slightly, to $13.60 at the end of the quarter.

And with that, I will open it up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Joel Houck of Wells Fargo.

Joel Jerome Houck - Wells Fargo Securities, LLC, Research Division

I didn't have a name change. It's Joel Houck. Anyway, guys, I'm wondering, given kind of what we're seeing now is kind of a troughing, if you will, of yields, prepayment speeds look to be well contained. If you were to go out and replace the current portfolio at the new marginal cost of funds, what would that represent in terms of kind of a marginal spread? Obviously, you can't necessarily do that. Swaps are dynamic. But can you give us a sense for where that spread would be at today?

Robert R. Spears

Yes. I think you're looking at roughly 125 basis points, buying the same type of products that we've been buying in the past.

Joel Jerome Houck - Wells Fargo Securities, LLC, Research Division

Okay. And so obviously, with these swaps rolled off, I mean, $1.8 billion is a sizable amount relative to your book, and we see the stuff you placed on. One would think that the spreads are going to kind of move up to that level for the balance of the year. Is that a good assessment?

Robert R. Spears

Well, it's obviously dependent on prepayments and a lot of other factors, but spreads are fairly stable on our existing book. And at the margin, we're replacing that at those same spreads or slightly higher.

Operator

Our next question comes from Mike Widner of KBW.

Michael R. Widner - Keefe, Bruyette, & Woods, Inc., Research Division

Let me just follow up on Joel Houck's question there. The 125 basis points you talked about, I would assume you're talking kind of incremental investments in new production ARMs, but one of the things that's most interesting about your portfolio is obviously the high concentration of seasoned ARMs, which would be much more difficult to replicate today. So I'm just wondering if you could elaborate a little on where you're making your incremental investments to replace runoff today, if it's purely in the kind of new issue market and what you think the investment opportunities are if one did try to reconstruct your portfolio by buying heavily seasoned ARMs or current reset ARMs.

Robert R. Spears

Sure. It's very difficult to buy seasoned securities that get high enough yield to throw off in those kinds of spreads. And so we're very fortunate to have our legacy book. And we have disclosed that over the last several months, the bulk of our purchases have been in longer-reset securities. The dollar prices on some of the very seasoned securities are well into the 106s and are throwing off 1% or sub 1% type yields. So incrementally, we don't find those attractive on the purchase front. Obviously, we -- once again, we're very fortunate to have our legacy book at the prices that we own it at. But most of what we're finding, not necessarily in new production, we're buying a combination of new production and seasoned securities. But the large percentage of them is in the kind of the 51 to seasoned 71 area, kind of in there.

Michael R. Widner - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And as far as the hedging goes, I mean, again, I think I understand what you're doing. But as people look across the group, they look at your hedge book and they say as a percent of repo or however you want to mention it, you've got one of the lower 30-something percent of your repo hedged. I'm just wondering if you could talk about that and how that -- obviously, you also talked about in the press release a lot of your legacy swaps running off and that benefiting funding cost. But I'm just wondering if you could talk little bit about the current investments today, what that might or might not do to the complexion of your, yes, your swap positions, your repo positions and...

Robert R. Spears

Well, also, you have to look at that 32% number that you threw out. It's just our current swaps. We also have forward-starting swaps that we count those in our hedged position. And so when we're looking at our duration gap of 1 month, we've extended our liabilities to 9 months. We include those forward-starting swaps in there. So I would view that 30% number as on a low side. I think you have to look -- take the forward swaps into account as well with...

Andrew F. Jacobs

Which takes us almost to 50%.

Robert R. Spears

Yes, exactly. I mean, we have -- with the percentage of longer-reset securities we have in our book, I think we have those basically 100% hedged, the longer-reset securities that is.

Michael R. Widner - Keefe, Bruyette, & Woods, Inc., Research Division

Yes, and so I mean, I guess specifically the way you guys look at the current reset stuff, if I understand you correctly, you don't need to put a whole lot of swaps on against that because it's current reset, and therefore, it's sort of hedged in and of itself. And so we should think about this...

Robert R. Spears

I mean, our biggest -- if we have any duration extension, it would be in our longer-reset book. And so we hedged a much higher percentage of that than we do our shorter-reset book.

Phillip A. Reinsch

I mean, our longer-to-reset book that we do put those hedges on is the shortest end of anybody else's portfolio in the peer group.

Operator

Our next question comes from Stephen Laws from Deutsche Bank.

Stephen Laws - Deutsche Bank AG, Research Division

Maybe just if you guys could touch on some of the macro bigger issues out there. I know a recent article about potential concentration risk with the growth among the mortgage REIT sector even though it still is only about 6% to 7% of the total agency MBS market. And then maybe kind of your views on the Fed buying program, how long it lasts, what -- any thoughts you guys might have on those 2 kind of bigger picture issues would be great.

Andrew F. Jacobs

Yes, I'll give that one a try. I think the article that came out, I guess, last Friday that I think a lot of people are reacting to or at least commenting on pretty much is old news. I mean, it's not anything that surprised anybody. And I think you've seen kind of -- at least in our stock price, our stock price didn't react negatively to that article at all because I think it's old news. From the standpoint of our group being about $400 billion in mortgage securities, I mean, the big fixed income manager today is the Federal Reserve. And from a systemic standpoint, I mean, they don't have to mark to market, I understand, but from the standpoint of if the mortgage-backed security market were to fall abruptly, which is kind of what the articles are alluding to, there could -- relative to the bubble, well, the Federal Reserve has a huge mark against their book. And I think one thing you have to realize, I think, is less thought of today is that the Federal Reserve actually makes its dividend payment into the treasury, that's part of the cash flow of the United States government and all of its programs. And the Federal Reserve, if they have a huge loss on something, that dividend basically can go away for a while. And so a sizable reduction and drop in prices is not good for the fixed income portfolio that the Fed owns. So I think they'll be very careful in how they advance through that. And dispositions or whatever future policy, I think that's a significant consideration at the end of the day. So I think that they -- from the systemic side of mortgage REIT, I'm not worried -- I mean, $400 billion is a sizable part of the $5 trillion to $6 trillion worth of security. But overall, it's -- I think the key is it's the second most liquid security in the world behind treasury. And it's not the same kind of thing we saw in the nonagency world back in the 2008 environment. So I think the liquidity of that there -- is not going away. So I'm not too concerned with that. And like I said, I think the story was old news.

Operator

[Operator Instructions] As there are no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Lindsey for any closing remarks.

Lindsey Crabbe

Thanks again for joining us today. If you have any further questions, please give us a call, and we look forward to speaking with you next quarter.

Operator

The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect.

Lindsey Crabbe

Thank you, Jessica.

Operator

Thank you very much.

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