I Wouldn't Buy Capstead Mortgage With YOUR Money

| About: Capstead Mortgage (CMO)


I recently wrote about how Capstead Mortgage was a sinking ship to be avoided.

Some have said I am wrong, and I admit shares are now approaching a 52-week high.

The emperor has no clothes.

I recently wrote about how Capstead Mortgage (NYSE:CMO) was a sinking ship to be avoided. That was because there was an 11.5% dividend cut. So why this cut? Well, the fact is that 2015 was a rough year for the name, though in Q1 2016, the company beat consensus estimates on the top line and had an in-line bottom-line result. But Capstead reported net income of just $27.4 million or $0.25 per share compared to net income of $28.4 million or $0.26 per share in Q4 2015. This was a slight sequential decline, but was good performance. But not enough to continue paying the dividend of $0.26. The key metrics suggested the name was to be avoided. That said, fast forward a few months and the name is approaching a 52-week high. This is not because of company-specific strength exactly, but sector-specific strength. Many mREITs are doing well. But, to be fair, I was wrong to say avoid the name, given the outcome. Let us turn to the numbers.

In the recently reported Q3 2016, the company missed consensus estimates on the top-line and bottom-line results. That is not so good. Capstead reported net income of just $16.4 million or $0.13 per share compared to net income of $21.6 million or $0.19 per share in Q2 2016. This was a sequential decline and is not a great showing. Now the company of course paid its newly cut dividend of $0.23. To understand if the dividend was covered, we look to core income. Well, pretty poor. Core income came in at $0.16 per share. This is a $0.07 shortfall. Ouch.

As you know, there are some key metrics we have to watch every quarter. Specifically, these are most importantly the book value, net interest rate spread and constant prepayment rate. Well, book value declined once again. The once stable book value continues to fall slowly. It fell just a penny however to $11.21. That is not bad, and pretty stable, but has long been on the decline over the last two years. Ouch. As of now, the stability is not there. There is still a sizable discount-to-book, however, it is important to note that gap is closing. The stock at $10.38 now trades at a 7.4% discount-to-book. Let's not forget that just over a year ago, it traded at a premium-to-book because of its reliability. However, just six months ago, the discount was 24%. So progress is being made.

How about the net interest rate spread, and yes, the critical constant prepayment rate? The constant prepayment rate has been way too high for this company. The constant prepayment rate skyrocketed again to an even disgustingly higher rate of 25.8%. You can call me wrong all you want on the share price, but I wouldn't touch this name with YOUR money. Because it rose, I expected the net interest rate spread to narrow. And indeed it did, with spreads coming in at 0.6%. That is pitiful in this sector.

Capstead is a mess. I don't care if a sector rebound took this one higher. Good for you, you have a chance to get out. If you must play it, then do it in the preferred shares. Considering prepayments are the highest in the sector, this is a major problem. Thus, I recommend avoiding this name. Strike that. I wouldn't buy it with your money.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles that are time sensitive. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in CMO over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.