Capstead Mortgage Corp (CMO) This fall 2020 Earnings Name Transcript

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Capstead Mortgage Corp (NYSE:CMO)
This fall 2020 Earnings Name
Jan 28, 2021, 9:00 a.m. ET

Contents:

  • Ready Remarks
  • Questions and Solutions
  • Name Individuals

Ready Remarks:

Operator

Good day, and welcome to the Capstead Mortgage Company’s Fourth Quarter 2020 Earnings Convention Name. [Operator Instructions]

I would now like to show the convention over to Lindsey Crabbe, Supervisor of IR. Ms. Crabbe, please go forward.

Lindsey CrabbeSupervisor of Investor Relation

Good morning. Thanks for attending Capstead’s fourth quarter earnings convention name. The fourth quarter earnings launch was issued yesterday, January 27, 2021, and is posted on our web site at www.capstead.com beneath the Investor Relations tab. The hyperlink to this webcast can be within the Investor Relations part of our web site. An archive of this webcast and a replay of this name will probably be obtainable by April 28, 2021. Particulars for the replay are included in yesterday’s launch. On the decision in the present day are Phil Reinsch, President and Chief Government Officer; Robert Spears, Government Vice President and Chief Funding Officer; and Lance Phillips, Senior Vice President and Chief Monetary Officer.

Earlier than we get began, I wish to remind you that a few of in the present day’s feedback may very well be thought of forward-looking statements pursuant to the protected harbor provisions of the Non-public Securities Litigation Reform Act of 1995 and are primarily based on sure assumptions and expectations of the administration. As well as, sure phrases used on this name are non-GAAP monetary measures, reconciliations of that are offered within the firm’s earnings launch and accompanying tables or schedules, which have been filed on Kind 8-Okay with the SEC and may additionally be accessed by the corporate’s web site. For an in depth checklist of all the chance components related to our enterprise, please check with our filings with the SEC, which can be found on our web site. The data contained on this name is present solely on the date of this name, January 28, 2021. The corporate assumes no obligation to replace any statements, together with any forward-looking statements made throughout this name.

With that, I’ll flip the decision over to Phil.

Phillip A. ReinschPresident and Chief Government Officer

Thanks, Lindsey, and thanks, everybody, on your curiosity in Capstead Mortgage. After I make a couple of transient remarks, Lance will give a fast recap of the fourth quarter, and Robert goes to supply us with some present market coloration. Then we’ll open the decision as much as questions. We’re happy to report one other regular quarter with decrease borrowing prices, offsetting the results on portfolio yields to continued excessive mortgage prepayments as Individuals proceed to benefit from generational lows in mortgage charges to refinance or buy a brand new house. On a core earnings foundation, we once more earned our $0.15 widespread dividend, producing an 8.85% annualized return on widespread fairness. For all of 2020, we earned 9% by this measure. We completed these returns with decrease leverage and portfolio balances publish pandemic. Widespread dividend itself was unchanged for 5 quarters now.

And our core earnings met or exceeded the dividend in every of those quarters regardless of the market disruptions skilled in March. We’re the one mortgage REIT that may make that declare. The truth is, taking a look at friends within the residential mortgage REIT house, on common, their dividends at the moment stand at about 50% of what they have been pre-pandemic, and that is a stark distinction to our regular efficiency. Our e book worth is down $0.04 within the fourth quarter, which along with a $0.15 widespread dividend, resulted in a three-month financial return of 1.6% or 6.5% on an annualized foundation. Because the pandemic induced such earnings disruption in March, and thru year-end, e book worth was up $0.69, which along with $0.45 in widespread dividends, resulted in an financial return of about 19% or 25% annualized. So far in 2021, e book worth has little change, down $0.01 to $6.75 a share. Trying ahead, we’re optimistic that there’ll not be a repeat of the market disruptions skilled in March, given the decrease leverage ranges out there and the Fed bond-buying applications. Nonetheless, mortgage prepayments stay at excessive ranges in no small half as a result of Fed’s persevering with heavy involvement out there. That is having the impact of decreasing returns and crowding out non-public capital, making it tougher to reinvest capital made obtainable from portfolio runoff at enticing ranges. We anticipate prepays to reasonable over time as runoff is changed with slower paying newer manufacturing with the seasoning of present holdings and with decrease coupon rates of interest on our at the moment resetting bonds. Given these market situations, we’re being considered in deploying our liquidity, constructing flexibility to doubtlessly benefit from alternatives as they unfold within the coming quarters.

With that, I am going to flip the decision over to Lance and Robert.

Lance J. PhillipsSenior Vice President, Chief Monetary Officer and Secretary

Thanks, Phil. We reported a GAAP web earnings of $23.3 million this quarter or $0.19 per diluted widespread share. Our core earnings have been $19.7 million or $0.15 per diluted widespread share. As a reminder, our core earnings exclude realized and unrealized losses on our portfolio-related rate of interest swap agreements. We included a reconciliation of our GAAP to core earnings on Web page 9 of our press launch. Ebook worth decreased $0.04 per share in the course of the fourth quarter, ending at $6.76 per widespread share, with spinoff associated will increase of $0.10 being offset by $0.14 in portfolio associated declines, largely resulting from runoff. Portfolio yields averaged 1.55% in the course of the quarter, a lower of 30 foundation factors from the 1.85% we reported within the prior quarter. Yields declined resulting from decrease coupon rates of interest on acquisitions and on present loans that reset to decrease present prevailing rates of interest, in addition to greater yield changes for funding premium amortization resulting from persevering with excessive ranges of mortgage prepayments.

Our portfolio associated borrowing prices, after adjusting for our hedging actions, averaged 0.37% in the course of the fourth quarter, 30 foundation factors decrease than within the prior quarter, resulting in roughly a one foundation level enchancment in our web curiosity spreads. Because of payouts in the course of the quarter at December 31, the fastened pay fee on our swap e book was 0.04%, a decline of 65 foundation factors from charges in impact on September 30. These decrease fastened charges going ahead will profit future earnings. Robert?

Robert R. SpearsGovernment Vice President and Chief Funding Officer

Thanks, Lance. The yield curve steepened considerably in the course of the fourth quarter with 10-year yields rising 23 foundation factors whereas future yields declined foundation factors. Long run, this development is a optimistic for our valuations in ARM provide. There was, nonetheless, short-term disruption in new difficulty ARM MBS originations as a result of transition from LIBOR to SOFR indexes. Many originators stop taking LIBOR purposes early within the quarter, however did not get SOFR product rolled out. Consequently, fourth quarter manufacturing was skewed to the draw back, and it was on the lowest degree of the yr at roughly $1 billion. On the identical time, an especially robust financial institution bid for brand new difficulty ARMS of all styles and sizes brought on spreads to tighten dramatically on the bottom coupon, latest paper that’s perceived to be immune from prepays.

Additionally, secondary promoting was very broad within the quarter. Because of these cross currents, we’re at the moment seeing extra worth within the season ARM stays versus new points. Prepayments stay elevated. We anticipate this development to proceed for the following a number of months. As we transfer to 2021, the yield curve development and has remained intact. We’re beginning to see new SOFR ARMS popping out and block ahead trades. As a matter of truth, we have already seen over $200 million of this new SOFR paper in January alone. And whereas spreads are comparatively tight on this paper, the truth that provide is beginning to come out in a extra normalized trend is optimistic. Nonetheless, I’d anticipate the market to change into far more normalized so far as manufacturing and quantity round March.

And with that, we’ll open the decision up for questions.

Questions and Solutions:

Operator

[Operator Instructions] And the primary query in the present day comes from Steve Delaney with JMP Securities.

Steve DelaneyJMP Securities — Analyst

Hey, good morning everybody. How are you?

Robert R. SpearsGovernment Vice President and Chief Funding Officer

Good morning.

Steve DelaneyJMP Securities — Analyst

Thanks for the feedback and the nice launch final evening. The — Robert, you talked about type of the tightness out there, lots of that seems like simply provide and demand. However assist us get a way for as you see the market in the present day, what would — what — give us a variety or an concept of what your minimal ROE hurdle is to speculate new money? It sounds such as you’ve sort of stepped again and that minimal hurdle, how does that change between, say, present reset and recent paper — longer length paper?

Robert R. SpearsGovernment Vice President and Chief Funding Officer

Sure, certain. I imply I feel simply interested by it, we’ve most well-liked ROE at 7.5. And so at a minimal, we’re not going to speculate except we will get an 8% levered return. And so proper now, we’re seeing leverage anyplace from 7.25 to eight instances. We’re seeing 8% to 9% returns in some components of the market, however that is primarily the pace of the house. With the place new manufacturing is buying and selling proper now, it is within that e book. I’d anticipate these spreads to normalize, although, as manufacturing picks up. However clearly, fastened charges have tightened as properly, so ARMS do not simply commerce in a vacuum. The lengthy half proper now’s how lengthy the banks can final. Loads of instances, these guys are in heavy the primary quarter, after which they again away.

In order that’s one of many wildcards. However — so the following couple of months, I feel new difficulty paper’s going to remain on the upper aspect, and we’re in all probability not going to be tremendous lively in that house. We’re optimistic as we transfer by the yr, although, given the slope of the curve, and what we’re seeing already I imply, a few of the bigger originators are placing out $25 million, $30 million block measurement bottoms out into March and April already. And so we’re very optimistic about that over the approaching months. Not a lot within the first month or two of the yr, as a result of the trades we have seen thus far, new difficulty hybrid papers tightened additional, together with fastened charges. I imply so proper now, it isn’t overly compelling. We expect that would change over the following few months. So we’ll in all probability, within the brief run, stick extra to seasoned paper.

Steve DelaneyJMP Securities — Analyst

Received it. That is useful. And Lance, one for you. Your sort of expanded disclosure lately on honest worth swap maturity disclosures. And simply taking a look at your desk right here for December 31 versus 9/30. You have gotten rid of, clearly, some a lot greater value swaps, but in addition I feel you have switched to OIS swaps. Ought to I interpret this that whenever you say you have acquired a median fastened fee in any specific quarter, as an instance, third quarter of 2022, and it is just one foundation level. Is that simply your web between what I’d usually consider as a hard and fast pay versus obtain unfold on that swap contract?

Lance J. PhillipsSenior Vice President, Chief Monetary Officer and Secretary

No. That is really our common fastened pay.

Steve DelaneyJMP Securities — Analyst

That is your common repair pay?

Lance J. PhillipsSenior Vice President, Chief Monetary Officer and Secretary

For those maturing in that interval.

Steve DelaneyJMP Securities — Analyst

Proper. So that you’re principally saying you are paying one foundation level?

Lance J. PhillipsSenior Vice President, Chief Monetary Officer and Secretary

Sure. For that — you imply that third quarter instance, that swap notional quantity of $1.2 billion has a median fastened fee of 1 foundation level.

Robert R. SpearsGovernment Vice President and Chief Funding Officer

To follow-up on that. These — present two-year OIS swaps are at about eight foundation factors. And in order that one is within the cash proper now.

Steve DelaneyJMP Securities — Analyst

Okay. thanks. I’ll do a follow-up with you, Lance, within the subsequent day or two, simply simply to ensure I am clear on that for modeling functions. Thanks for the remark guys.

Robert R. SpearsGovernment Vice President and Chief Funding Officer

You wager.

Operator

Thanks. And the following query comes from Jason Stewart with JonesTrading.

Jason StewartJonesTrading — Analyst

Hello, good morning and congratulations on an important 2020. I feel the — good kudos for a very good efficiency in a tricky yr. I’ve a query on the yield adjustment within the fourth quarter. Lance, should you may quantify it, if potential? After which possibly type of set expectations for something that might happen once more within the first quarter or if that type of degree set the numbers there?

Lance J. PhillipsSenior Vice President, Chief Monetary Officer and Secretary

So on the fourth quarter yield changes, it was — we disclosed — we’ve not been disclosing the breakdown of that, however it’s been fairly constant within the seven basis-point yield adjustment, I wish to say, during the last second half of the yr. For the primary quarter, as a reminder, a few of our friends identical to speeds on a fairly common foundation, after which they again it out of core earnings. We historically do this on an annual foundation. And have a look at like pace e book, there isn’t any requirement for that, however that is how we sort of attempt to look somewhat extra long run. We have achieved that previously during the last couple of years at the least within the first quarter, and I would anticipate that is what we’ll have a look at once more this yr. With the upper prepayments, clearly, there’s an opportunity we have moved these hurries up and if we do, we would definitely disclose the affect or sort of the — what others name the catch-up or what we’d simply say that like pace adjustment, we’d disclose that within the first quarter and break that out for you.

Jason StewartJonesTrading — Analyst

Okay. thanks. After which clearly, we have seen somewhat little bit of whips on charges within the first quarter thus far. When you would not thoughts simply strolling us by somewhat little bit of how the portfolio has carried out when it comes to length and extension. And I recognize the feedback on new difficulty, however simply in the best way that the legacy has traded thus far given the brief length nature of it and what we have seen occur in charges, I feel that might be useful.

Lance J. PhillipsSenior Vice President, Chief Monetary Officer and Secretary

Positive. And as Phil talked about, our e book worth was down $0.01 in our final March, which was as of shut of enterprise — market shut of enterprise final Friday. And so primarily, should you have a look at the curve, two to three-year a part of the curve is just about unchanged. And given the length of our e book, it actually hasn’t moved quite a bit, though spreads on newer difficulty, decrease coupon paper have tightened. So we have seen a few of these costs on the decrease coupon paper that we personal enhance by as a lot as 0.25 level. A lot of the different paper is — comparable paper out there may be pretty flat. And so not lots of motion thus far to characterize the ARM market usually, what is going on on proper now. Most newer ARM paper’s buying and selling someplace between 104.25 and 105.25. And there is lots of value compression, identical to you see in fastened fee, as a result of it is sort of a pace play proper now. So on this atmosphere, identical to the fastened fee market, the higher performing paper proper now’s both decrease coupon or diverse season with a very good pace rating. Does that reply your query?

Jason StewartJonesTrading — Analyst

Sure. That is tremendous useful. I simply suppose that with the context when it comes to portfolio efficiency and the transfer in long run charges, it is useful to stratify the best way that the portfolio is performing. In order that’s useful. Thanks.

Robert R. SpearsGovernment Vice President and Chief Funding Officer

Positive.

Operator

Thanks. And the following query comes from John Islands with SG Capital.

John IslandsSG Capital — Analyst

Sure. I used to be simply curious, are you able to speak somewhat bit about — I am certain you are pissed off by the valuation in your inventory simply relative to — you guys being the one mortgage REIT that did not minimize the dividend, and so forth. You are buying and selling about 81% of e book. Because you’re bringing down leverage, I imply do you look to doubtlessly begin to deploy a few of that capital and purchase the inventory again down right here at these ranges?

Lance J. PhillipsSenior Vice President, Chief Monetary Officer and Secretary

Sure, that is an important query. We’re buying and selling at a decrease a number of than we expect we deserve, clearly, in contemplating that we’re 100% company e book. And we’ve carried out properly from a money move perspective. The — with the leverage coming down somewhat bit within the fourth quarter with the provision and demand dynamics which were in place that Robert described, we’ll see how that performs out. However we we’d in all probability run down — run leverage doubtlessly even decrease by the top of the primary quarter if we do not see good alternatives to deploy capital. So that offers us lots of flexibility to have a look at — to have a look at buybacks or different maneuvers to make use of that capital. So we’re actually open to doing what’s greatest for our stockholders in that regard.

John IslandsSG Capital — Analyst

Okay. After which the opposite query that I’ve for you is, AGMC on their name — I do know your e book is completely different, and so forth, however they have been speaking about how they suppose there’s doubtlessly attending to some sort of burnout on refis and that we’re getting nearer to that, and so forth. Are you able to give us any insights on simply sort of what you see in refis relative to the ARM market?

Robert R. SpearsGovernment Vice President and Chief Funding Officer

Positive. I imply I feel over time, most segments of the MBS market begin to exhibit burnout and ARMS will not be completely different in that regard. I’d suppose that prepayments will stay elevated all through most of this yr. After which after that, you hit the purpose the place just about all people on the market may have as refi. And so the dynamics proper now, although, there’s — over the following six to 9 months with like speeds are going to be elevated. And I feel after that, you need to begin to see some burnout exhibited. And likewise the distinction too in ARM e book versus the fastened fee e book we’ve, a shorter reset, securities which can be resetting decrease in deal. A completely listed ARM on the season brief reset paper to the borrower now’s round 2.5%. And so if these loans reset downward, they’ll decelerate as properly. And that is not essentially burnout, however it’s a pleasant characteristic to our portfolio.

The cohorts which can be going to stay considerably quick would in all probability be no completely different than if you concentrate on the fastened charges when it comes to the coupons that we’ve three and better, as an illustration, these guys are going to stay quick for some time. However all in all, after we get by the primary six to 9 months of this yr, we expect we will see speeds begin to reasonable.

John IslandsSG Capital — Analyst

Okay. Sure, go forward, I am sorry.

Lance J. PhillipsSenior Vice President, Chief Monetary Officer and Secretary

Nicely, simply actual fast apart to Robert’s level about our present resetting portfolio, we had a request to extend our disclosure relative to how these bonds will reset within the coming yr or so. So we added a sentence to that impact on the final web page of the press launch, and it is…

John IslandsSG Capital — Analyst

36%, proper? 36% in that — six months.

Lance J. PhillipsSenior Vice President, Chief Monetary Officer and Secretary

Sure, there’s 36% which can be going to, on common, reset in six months’ time, however we improved the disclosure to point that 22% of that quantity will — that reset will happen within the subsequent quarter and one other 33% within the second — within the quarter after that, which might be the third quarter. After which the remaining 40% over the next six months. So we gave some further disclosure there.

John IslandsSG Capital — Analyst

And we — as traders, although, we must always simply take into consideration that as optimistic ramifications as clearly, the reset the yield will come down, however there will not be runoff as a result of almost certainly, it isn’t going to refi, appropriate?

Lance J. PhillipsSenior Vice President, Chief Monetary Officer and Secretary

Sure. These of us could have an entire lot much less incentive to refinance after their coupons reset down. That core of the portfolio already is paying slower than the bonds Robert was referring to have a hard and fast coupon with years to go, as a result of they already know or they need to know that they will get one thing out of a coupon reset with out having to do something about that. It’s going to simply occur. So they will not essentially refinance in anticipation of a decrease coupon on their bonds. However it is going to actually be affirmation of that when the mortgage goes down.

Robert R. SpearsGovernment Vice President and Chief Funding Officer

With out moving into the mathematics, as an illustration, a 5 CPR drop in speeds on a season bond might throw up a better yield on the decrease coupon than what it does now. So speeds are very levered in that sort of paper. And so all in all, the pace decline would greater than offset the detriment of the coupon loss.

John IslandsSG Capital — Analyst

Received it. After which if I may simply ask you sort of an even bigger image. I imply clearly, we have seen this steepening considerably in two of the 10s, which ultimately ought to have optimistic ramifications on your portfolio. Are you able to simply speak somewhat bit about sort of what we have to see possibly in fixed-rate mortgages earlier than ARMS actually begin to possibly explode from a manufacturing standpoint. You talked about what was happening in LIBOR versus SOFR, and that is sort of a mechanical difficulty. However I assume, if — what are we rooting for to occur?

Robert R. SpearsGovernment Vice President and Chief Funding Officer

Nicely, I imply already with the steepness that we have seen, originators are on the market with, say, 7/1 ARMS and as a lot as 3/eighth of fee distinction, cheaper than a 30-year fastened. And from what we’re listening to from guys which can be involved with huge originators are seeing a giant pickup in ARM manufacturing versus the fourth quarter, albeit from a really low degree. And in order that steepness alone is inflicting a rise. If any steepness from there would solely improve provide liquidity and attractiveness, I feel, of the ARM market. So we’re optimistic about provide going ahead within the atmosphere the place now it sees additional, and it’ll get higher.

John IslandsSG Capital — Analyst

Okay. Thanks for a lot for answering my questions. I actually recognize it. And I hope you purchase a few of the inventory again.

Robert R. SpearsGovernment Vice President and Chief Funding Officer

Thanks.

Operator

Thanks. And the following query comes from Derek Hewett with Financial institution of America.

Derek HewettFinancial institution of America — Analyst

Good morning, everybody. Form of given these near-term headwinds on new difficulty yields and the portfolio trending modestly decrease and presumably decrease leverage should you do not buy again any inventory, at the least within the close to time period. How ought to we take into consideration the sustainability of the present dividend? Are these near-term — are these headwinds sort of within the near-term and issues begin to normalize in sort of Q2 and past? Or what are the expectations round these tendencies?

Robert R. SpearsGovernment Vice President and Chief Funding Officer

There’s lots of transferring components, proper, and an entire lot of optionality in the place we may very well be from an earnings perspective quarters down the highway. Loads of it is going to rely on what we have been simply speaking about to how a lot the yield curve steepens, if any. And if we will purchase bonds at respectable ROEs, whether or not we preserve leverage on the ranges we’re at. If we do not, what can we do with the capital, can we maintain it as dry powder, can we deploy it by shopping for again our personal capital or in any other case. So there’s lots of unknowns this yr. It is in all probability extra — it is extra unsure when it comes to a few of these components than you would possibly ordinarily have at this stage. So we’re not likely ready to say an entire lot about the place that goes, however we are going to try to carry on to our dividend degree. If it appears to be like to be a short lived decline in core earnings, we’ll — we do not wish to disrupt the — our sample of dividends for one thing that is transitory.

Derek HewettFinancial institution of America — Analyst

Okay, nice. Thanks.

Operator

Thanks. [Operator Instructions] And the following query comes from Eric Hagen with BTIG.

Eric HagenBTIG — Analyst

Hey, Thanks, good morning guys. A follow-up on originators rolling out SOFR ARMS. Are you able to simply shed some mild on the product itself, what are the margins and caps and flooring being supplied to debtors?

Robert R. SpearsGovernment Vice President and Chief Funding Officer

Positive. To this point, most of what is come out has been within the 7/1 house. And the distinction is the previous 7/1 LIBOR had margins of web margins of plus one 60 or so. The newer SOFR paper has come out, it is at margins round two 12. It is a theoretically 5 — 1/5 cap construction, if you’ll, may the resets of flight. So it may go — it might reset up 5% on the first reset after which 1% each six months after that. And so should you sort of have a look at the way it’s buying and selling thus far, it is actually not buying and selling materially completely different than what a LIBOR — comparable LIBOR ARM would have traded. It is principally buying and selling off the coupon with individuals assuming the margin of adjustment of roughly 50-plus foundation factors over time, for the SOFR index is a good adjustment.

Derek HewettFinancial institution of America — Analyst

It is actually fascinating coloration. Thanks. I hope you guys are properly.

Robert R. SpearsGovernment Vice President and Chief Funding Officer

Positive, thanks.

Operator

Thanks. And as that was the final query, I wish to return the ground to Lindsey Crabbe for any closing feedback.

Lindsey CrabbeSupervisor of Investor Relation

Thanks once more for becoming a member of us in the present day. You probably have additional questions, please give us a name. We sit up for talking with you subsequent quarter.

Operator

Thanks. This concludes the question-and-answer session and — in addition to the decision. Thanks for attending in the present day’s presentation. You might now disconnect your traces.

Period: 29 minutes

Name members:

Lindsey CrabbeSupervisor of Investor Relation

Phillip A. ReinschPresident and Chief Government Officer

Lance J. PhillipsSenior Vice President, Chief Monetary Officer and Secretary

Robert R. SpearsGovernment Vice President and Chief Funding Officer

Steve DelaneyJMP Securities — Analyst

Jason StewartJonesTrading — Analyst

John IslandsSG Capital — Analyst

Derek HewettFinancial institution of America — Analyst

Eric HagenBTIG — Analyst

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