Capstead Mortgage Management Discusses Q1 2014 Results - Earnings Call Transcript

May. 1.14 | About: Capstead Mortgage (CMO)

Capstead Mortgage (NYSE:CMO)

Q1 2014 Earnings Call

May 01, 2014 9:00 am ET

Executives

Lindsey Crabbe

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

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

Analysts

Steven C. Delaney - JMP Securities LLC, Research Division

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

Operator

Good morning, and welcome to the Capstead Mortgage Corporation First Quarter Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Lindsey Crabbe, Manager of Investor Relations. Please go ahead.

Lindsey Crabbe

Good morning. Thank you for attending Capstead's First Quarter 2014 Earnings Conference Call. The first quarter earnings press release was issued yesterday, April 30. The press release is posted on our website, at www.capstead.com, under the Investor Relations tab. The link to this webcast is also in the Investor Relations section of our website and an archive of the webcast will be available for 60 days. A replay of this call will be available through July 1. Details of the replay are included in yesterday's release.

With me today are Andy Jacobs, President and CEO; Phil Reinsch, Executive Vice President and CFO; and Robert Spears, Executive Vice President and Director of Residential Mortgage Investments.

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, May 1, 2014. 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

Thank you, Lindsey. Well, good morning, and welcome to our first quarter 2014 earnings call. As usual, I'm joined by Robert Spears and Phil Reinsch.

We will be -- both -- all of us will be available after a few opening remarks.

As everyone knows, the Federal Reserve's Open Market Committee, yesterday announced, it would continue to taper its monthly purchases. This makes the fourth such announcement and it reduces monthly purchases to $25 million and $20 million for treasuries and agencies, respectively.

In spite of this tapering, prices for mortgage-backed securities have remained strong. And the 10-year treasury rate has declined from 3% at the end of 2013 at -- now averaging so far this year at about 2.75%.

Overall, this winding down of purchases by the Fed is not directly relevant to us because we focus on the shorter-duration mortgage securities, which is not what the Fed has been buying. So we've had more stability in our pricing throughout this.

Now, I'll talk about operating results. Net income in the first quarter was $38.4 million or $0.37 per common share. This compares to $37 million or $0.35 in the prior quarter. We increased our common dividend in the first quarter, 10% to $0.34.

Net interest margins improved to $44 million as financing spreads were higher by 5 basis points, averaging 130 basis points during the quarter.

Yields on the investment portfolio accounted for all of this increase, as our premium amortization on our portfolio declined by about $2.5 million, as mortgage prepayment rates declined 12% with an average 15.16 CPR in the first quarter.

Borrowing rates on retail, including the hedging-related costs, were unchanged quarter-over-quarter. Repo rates on our 30-day borrowings declined 4 basis points during the period, averaging 34 basis points for the quarter. However, this benefit for these lower repo rates was offset by a greater percentage of interest rate swap agreements moving into current-pay status.

Now, regarding our operating costs. As a percent of long-term capital, they averaged 96 basis points during the quarter, which was down from 107 in the previous quarter, which is reflective of primarily lower annual incentive compensation accruals.

Regarding the portfolio, acquisitions during the quarter were $644 million, while portfolio runoff was $610 million. Our leverage was basically flat at 8.52:1, as it was in the previous quarter.

We ended the quarter with a portfolio of about $13.5 billion, 57% of this portfolio was invested in current-reset on securities.

Our book value per share increased $0.12 to $12.59, primarily as a result of pricing improvements during the period. It was offset somewhat by lower values relative to -- primarily our trust-preferred -- $100 million in trust-preferred securities that we had longer-dated swaps on.

And lastly, the improvement in per share is that, our earnings were in excess of our dividends by about $0.03. So that goes directly to the book value side.

We were continuing to see lower repo rates in April. And if this trend continues, we -- this will offset upward pressure on borrowing costs associated with additional forward-starting swaps moving into current paid status during the quarter. We anticipate that prepayment rates will be only modestly higher this spring and summer, reflecting seasonal factors and a continued improving overall housing market.

As a result, we expect to report quarterly earnings over the remainder of 2014, consistent with these favorable conditions as both mortgage and prepayment -- mortgage and prepayment rates and borrowings.

With that, I'll open up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from Steve Delaney of JMP.

Steven C. Delaney - JMP Securities LLC, Research Division

Guys, things -- just looking at your quarter and kind of observing what's going on out there in the mortgage REIT space. I mean, things appear almost optimal to me when I look at the Capstead situation, I mean, you've got the portfolio kind of where you want it in terms of minimizing interest rate risk, prepays are slower, repo is cheaper. I mean, it's kind of in a situation, near-term, where it doesn't look like it can get much better, which I'm sure is a great position for you guys. So my question is, are there things that when you come in every day, are there things that you guys can still do to optimize returns and improve the portfolio? And if so, what are some of those things that you're focused on now to make a good situation even better?

Andrew F. Jacobs

I think just the overall key, our focus on the shorter duration is to hopefully minimize the volatility that others in longer-duration securities have. So we do -- we're always looking to see where things are going, where we can improve things. But for the most part, I mean, we -- our strategy -- this is where it's suppose to be. And this is why we very much stick to the shorter duration because it reduces -- it keeps the volatility down, and with the curve -- with the Federal Reserve kind of, I guess, the consensus is, is sometime in 2015, if not 2016, before we see higher short term interest rate. That's a big positive for this very short duration portfolio. I can't really speak to precisely what's going to happen on the longer end of that, but arguably, I think that's going to be higher, which isn't going to somewhat impact us negatively, but it will impact us positively. So they will have the tendency to even slow -- have slower prepayment rates. So we like where we are. This is where we were built to stay, and this is why we are content to stay in this particular space and have been. Over the last number of years, while people kept asking why don't we extend duration, the answer is, this is the reason we don't, we like being right here.

Steven C. Delaney - JMP Securities LLC, Research Division

And Robert, is the biggest challenge with the portfolio just trying to find even though runoff is pretty slow, I'm trying to find 600 to 700 million of bonds you really want to own? Is that the biggest challenge you're facing?

Robert R. Spears

Yes, that is a challenge now. Obviously, supply in the first quarter was down, in both ARMS and fixed rate. I mean, I think we don't have any problems facing runoffs, new issues supply was under $10 billion, but you also add $5 billion in secondary selling. And so -- it's a small challenge, but I don't think it's any issue going forward replacing runoff. And I wouldn't want to be looking to add serious size in the ARM space right now, just be careful of supply dynamics, but replacing runoff shouldn't be an issue.

Steven C. Delaney - JMP Securities LLC, Research Division

Okay, great. You guys mentioned that repo is lower yet, could give us a range for like where you're rolling -- funding at 30 days as we sit today?

Andrew F. Jacobs

I'm in the 29 to 31 area.

Operator

The next question will come from Joel Houck of Wells Fargo.

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

Just to kind of continue on Steve's question about runoff, can you talk about like when you are replacing a runoff, how much are you kind of buying in terms of new production, who your relationships are with and then how much are you buying just in the secondary market? And I'm sure that changes from month-to-month, but just a flavor for how you're going about replacing the runoff?

Robert R. Spears

Yes, sure. I mean, we are buying a combination of new issue and season securities. We are not going beyond 5/1s right now. So pretty much any thought -- anything inside of 5/1s is fair game if we see value there.

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

And maybe could explain in terms of like who your relationships are with like high net worth banks or just -- who actually are you buying...

Robert R. Spears

No, we are buying this from Wall Street firms.

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

Okay. And you said...

Robert R. Spears

We don't have any corresponding relationships, if that's the question. We strictly buy from the Street.

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

But you said you're not going out longer than 5 to 5/1.

Robert R. Spears

That's correct.

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

Okay, great. And then in terms of the taper, I think you guys talked about it, in the first part of the call, obviously, it doesn't impact your portfolio, as much as, obviously, so many other REITs. If we started to see some disruption later this year, as the Fed ultimately unwinds the taper? It sounds like you guys are just contented to stick with your strategy and portfolio, and so even if we saw more attractive spreads further out on a mortgage curve, it sounds like you guys aren't really interested in getting into that because it really kind of changes the overall way you have to run the business and hedge the portfolio, is that the right way to think about it?

Robert R. Spears

Well, not at this point in time, we don't foresee change in our strategy. Now having said that, if there is some spread widening in fixed-rate products, ARMs will widen to some degree and essentially all mortgage product will widen, but I would make the bet that ARMs will line significantly less than fixed-rates, if you do have that type of event. I still think there is a -- with a new bank capital guidelines and things on the horizon and people being defensive in general, I think shorter duration product will outperform longer duration product in a spread lining environment.

Andrew F. Jacobs

Well, just to emphasize what Robert said. With a potential widening in the fixed-rate, that doesn't mean we're there. It's the sympathy -- it's the ARMs will have some sympathy widening as well, likely. We will continue to be focused on the short duration. As I said, we've maintained this strategy for the last number of years and people were saying you can make more money if you extend it. This is -- we're exactly where we want to be and we want to continue to be there. And don't see any change any time.

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

Okay, great. I know you guys have a very, long successful track record and very good differentiation in the past, 12 to 18 months, given the high balance.

Operator

[Operator Instructions] And at this time, showing no additional questions in the queue. This will conclude our question and answer session. I would like to turn the conference back over to Lindsey Crabbe for any closing remarks.

Lindsey Crabbe

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

Operator

Ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation. You may now disconnect.

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