Capstead (CMO) on July 25, 2012 disclosed its performance for the second quarter of the current year, with performance being below consensus expectation. The company reported earnings per share of $0.4 against consensus expectations of $0.42. The reported earnings missed estimates by 5%. This is compared to a 7% positive surprise that the company posted for the first quarter of the current year. CMO has a history of beating its consensus earnings estimates by 108bps over the last 8 quarters, while it has been able to beat its revenue estimates by 85bps. The tables given below provide the details of the past 8 quarter earnings surprises. The stock is down 130bps since the announcement of the second quarter results.
Revenue figures in millions
We analyzed the stock on July 18, 2012 and concluded that since a majority of the company's adjustable rate mortgage investments have a weighted average duration of 24.25 years (long term in nature), its interest rate spread is bound to take a hit due to declining long term rates. We also thought that most of this depression in its interest rate spread will take effect by the end of the year, because a large proportion of the adjustable rate securities that the company holds have an annual reset date. This is why the interest rate spread that the company earned during the second quarter remained 1.37%, showing a decline of 15bps compared to the first quarter of the current year.
Sequential Performance Review
On revenues of $66 million, the company earned net income of $43.3 million for the second quarter. Even though the top line was marginally up 12bps, the company's bottom line plunged by 9% when compared to the first quarter of the current year.
The reported net interest margin or spread that the company earned during the second quarter fell by 15bps to 1.37% due to reasons that we covered in our previous report. Higher prepayments due to government-sponsored HARP and record low mortgage rates pushed premium amortization charge for the company, and resulted in a decline of 10bps in the yields that CMO earned on its interest earning assets during the second quarter. The bank earned a 1.98% yield on average on its interest earnings assets. Since the company exclusively invests in adjustable rate mortgages, the decline in asset yields is less as compared to REITs that mainly invest in fixed rate mortgage. The effect of the decline in the weighted average coupons on the adjustable rate mortgages that the company holds was a modest 4bps. However, as mentioned above, we expect the effect to be amplified by the end of the year, given the prevalent interest rate scenario. Contrary to our expectations, the interest rate that the company pays on its interest bearing liabilities (repurchase agreements) surged by 5bps to 0.61%.
The company's leverage largely remained flat at 8.05 times, while it added $787 million worth of new securities to its assets portfolio, and raised $62 million in new equity during the second quarter.
American Capital Agency (AGNC) and Annaly Capital Management (NLY), the other two mortgage REITs mostly followed, are scheduled to announce their performances for the second quarter on August 2, 2012.
In conclusion, Capstead offers an attractive dividend yield of 11.42%, which is also sustainable. This we say after looking at the company's operating cash flow yield of 16%. Where the use of adjustable rate mortgage loans reduces the prepayment risk for the company, the annual reset date for these securities further pushes any significant decline in the yields earned on its assets. The company will face headwinds from the declining interest rate environment, however, we believe the interest rate margin will not be depressed to levels where CMO's ability to continue its current shareholder distributions will be disturbed. Therefore, we reiterate our buy rating for the stock. However, investors who are interested in the stock should not expect to find any significant price appreciation.