-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QyflL1hIVsF4wKzXKQXfIXgihHXMzSEtp/NHl3lOjOOk9WtjoAw0aUDlpZ+rwWfZ aEf6xDidZpWuycTrD0fCLw== 0000950134-03-003572.txt : 20030307 0000950134-03-003572.hdr.sgml : 20030307 20030307170303 ACCESSION NUMBER: 0000950134-03-003572 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030307 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPSTEAD MORTGAGE CORP CENTRAL INDEX KEY: 0000766701 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 752027937 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-08896 FILM NUMBER: 03596692 BUSINESS ADDRESS: STREET 1: 8401 NORTH CENTRAL EXPRESSWAY STREET 2: STE 800 CITY: DALLAS STATE: TX ZIP: 75225 BUSINESS PHONE: 2148742323 MAIL ADDRESS: STREET 1: 8401 NORTH CENTRAL EXPRESSWAY STREET 2: STE 800 CITY: DALLAS STATE: TX ZIP: 75225 FORMER COMPANY: FORMER CONFORMED NAME: LOMAS MORTGAGE CORP DATE OF NAME CHANGE: 19891105 10-K 1 d03478e10vk.txt FORM 10-K ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES - ----- EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED:DECEMBER 31, 2002 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES - ----- EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ______________ COMMISSION FILE NUMBER: 1-8896 CAPSTEAD MORTGAGE CORPORATION (Exact name of Registrant as specified in its Charter) MARYLAND 75-2027937 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 8401 NORTH CENTRAL EXPRESSWAY, SUITE 800, DALLAS, TX 75225 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (214) 874-2323 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED ------------------- ------------------------------------ Common Stock ($0.01 par value) New York Stock Exchange $1.60 Cumulative Preferred Stock, Series A ($0.10 par value) New York Stock Exchange $1.26 Cumulative Convertible Preferred Stock, Series B ($0.10 par value) New York Stock Exchange
Indicate by check mark whether the Registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K: [ ] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 126-2 of the Act). YES X NO ----- ----- AT MARCH 6, 2003 THE AGGREGATE MARKET VALUE OF THE VOTING COMMON STOCK HELD BY NONAFFILIATES WAS $126,705,000. NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AT MARCH 6, 2003: 13,965,489 DOCUMENTS INCORPORATED BY REFERENCE: (1) PORTIONS OF THE REGISTRANT'S ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 2002 ARE INCORPORATED BY REFERENCE INTO PARTS II AND IV. (2) PORTIONS OF THE REGISTRANT'S DEFINITIVE PROXY STATEMENT, ISSUED IN CONNECTION WITH THE 2003 ANNUAL MEETING OF STOCKHOLDERS OF THE REGISTRANT, ARE INCORPORATED BY REFERENCE INTO PART III. ================================================================================ CAPSTEAD MORTGAGE CORPORATION 2002 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS PART I
PAGE ---- ITEM 1. Business............................................................................ 1 ITEM 2. Properties.......................................................................... 3 ITEM 3. Legal Proceedings................................................................... 3 ITEM 4. Submission of Matters to a Vote of Security......................................... 3 PART II ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters............... 4 ITEM 6. Selected Financial Data............................................................. 4 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations......................................................... 4 ITEM 7.a. Quantitative and Qualitative Disclosures About Market............................... 4 ITEM 8. Financial Statements and Supplementary Data......................................... 4 ITEM 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.............................................................. 4 PART III ITEM 10. Directors and Executive Officers of the Registrant.................................. 4 ITEM 11. Executive Compensation.............................................................. 5 ITEM 12. Security Ownership of Certain Beneficial Owners and Management...................... 5 ITEM 13. Certain Relationships and Related Transactions...................................... 5 ITEM 14. Disclosure Controls and Procedures.................................................. 5 PART IV ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K..................... 6 SIGNATURES ....................................................................................... 8 CERTIFICATIONS .................................................................................. 9
PART I ITEM 1. BUSINESS. Capstead Mortgage Corporation ("Capstead," the "Company" or the "Registrant") was incorporated on April 15, 1985 in Maryland and commenced operations in September 1985. Capstead operates as a real estate investment trust ("REIT") earning income from investing in real estate-related assets on a leveraged basis and other investment strategies. These investments currently include, but are not limited to, single-family residential adjustable-rate mortgage securities ("ARM") issued by government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities"). Capstead has also made limited investments in credit-sensitive commercial mortgage assets and in 2002 made its first direct investment in real estate. The Company continues to evaluate suitable real estate-related investments, which may include more credit-sensitive assets that can earn attractive returns due largely to a higher risk of default and reduced liquidity compared to Agency Securities. Capstead believes that such investments, when combined with the prudent use of leverage, can provide attractive returns over the long term with less sensitivity to changes in interest rates. Capstead's investment portfolios declined during 2002 and 2001 primarily because of relatively high levels of mortgage prepayments and a lack of suitable investment opportunities. Consequently, Capstead has returned a significant portion of its equity capital to its common stockholders the last two years. To the extent proceeds of runoff or asset sales are not reinvested, or cannot be reinvested, at a rate of return at least equal to the rate previously earned on that capital, earnings may decline. The future size and composition of Capstead's investment portfolios will depend on market conditions, including levels of mortgage prepayments and the availability on a timely basis of suitable investments at attractive pricing. For further discussion of the Company's business and financial condition, see the Registrant's Annual Report to Stockholders for the year ended December 31, 2002 on pages 30 through 36. EFFECTS OF INTEREST RATE CHANGES AND INTEREST RATE SENSITIVITY For discussion of effects of interest rate changes on the Company, see the Registrant's Annual Report to Stockholders for the year ended December 31, 2002 on pages 41 through 43. RISKS ASSOCIATED WITH CREDIT-SENSITIVE INVESTMENTS For discussion of risks associated with credit-sensitive investments, see the Registrant's Annual Report to Stockholders for the year ended December 31, 2002 on pages 43 and 44. RISKS ASSOCIATED WITH OWNING REAL ESTATE For discussion of risks associated with owning real estate, see the Registrant's Annual Report to Stockholders for the year ended December 31, 2002 on pages 44 through 46. OTHER INVESTMENT STRATEGIES The Company may enter into other short- or long-term investment strategies as the opportunities arise. COMPETITION In purchasing real estate-related assets, the Company competes with others in the real estate and banking industries including REITs, savings banks, commercial banks, mortgage and investment bankers, conduits, insurance companies, other lenders, other real estate investors and mutual funds. 1 REGULATION AND RELATED MATTERS Ownership of real estate subjects the Company to various federal, state and local regulatory requirements. For further discussion, see the Registrant's Annual Report to Stockholders for the year ended December 31, 2002 on pages 44 through 46. EMPLOYEES As of December 31, 2002, the Company had 15 full-time employees. TAX STATUS As used herein, "Capstead REIT" refers to Capstead and the entities that are consolidated with Capstead for federal income tax purposes. Capstead REIT has elected to be taxed as a REIT for federal income tax purposes and intends to continue to do so. As a result of this election, Capstead REIT will not be taxed at the corporate level on taxable income distributed to stockholders, provided that certain requirements concerning the nature and composition of its income and assets are met and that at least 90% of its REIT taxable income is distributed. If Capstead REIT fails to qualify as a REIT in any taxable year, it would be subject to federal income tax at regular corporate rates and would not receive a deduction for dividends paid to stockholders. If this were the case, the amount of after-tax earnings available for distribution to stockholders would decrease substantially. As long as Capstead REIT qualifies as a REIT, it will generally be taxable only on its undistributed taxable income. Distributions out of current or accumulated earnings and profits will be taxed to stockholders as ordinary income or capital gain, as the case may be. Distributions in excess of Capstead REIT's accumulated and current earnings and profits will constitute a non-taxable return of capital to the stockholders (except insofar as such distributions exceed the cost basis of the shares of stock) resulting in a corresponding reduction in the cost basis of the shares of stock. Distributions by the Company will not be eligible for the dividends received deduction for corporations. Should the Company incur losses, stockholders will not be entitled to include such losses in their individual income tax returns. The Company notifies its stockholders of the proportion of distributions made during the taxable year that constitutes ordinary income, return of capital or capital gains. For the last five years, 100% of the preferred stock distributions were characterized as ordinary income. For information regarding the characterization of common dividend distributions for the last five years, see the Registrants' Annual Report to Stockholders for the year ended December 31, 2002 on page 36. Capstead REIT realized substantial capital losses on the sale of mortgage assets in 1998 and 2000. The resulting unused capital loss carryforwards of $328 million as of December 31, 2002, will in all likelihood eliminate the potential for capital gain distributions through the year 2005 when these carryforwards expire. All taxable income of Capstead Inc. (which held the mortgage banking operations prior to their sale in December 1998) and its subsidiary, is subject to federal and state income taxes, where applicable. These non-REIT subsidiaries had net operating loss carryforwards of $6.1 million as of December 31, 2002 and sufficient alternative minimum tax credit carryforwards to offset the payment of federal income taxes on 2 $5.2 million of future taxable income, if any, earned by these subsidiaries. In addition, Capstead may find it advantageous to elect non-REIT subsidiary status for certain of its qualified REIT subsidiaries which would not have carryforwards available to offset the payment of federal income taxes on future taxable income, if any, earned by these subsidiaries. Capstead REIT's taxable income will include earnings of its non-REIT subsidiaries only upon payment to Capstead REIT by distribution of such earnings, and only if these distributions are made out of current earnings and profits. The foregoing is general in character. Reference should be made to pertinent Internal Revenue Code sections and the Regulations issued thereunder for a comprehensive statement of applicable federal income tax consequences. AVAILABLE INFORMATION Capstead files reports (Forms 8-Ks, 10-Ks and 10-Qs) and other information (including proxy and registration statements) electronically with the Securities and Exchange Commission ("SEC"). The SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers like Capstead that file electronically with the SEC. Press releases issued by the Company, recent annual reports to stockholders and links to other information filed with the SEC are available at Capstead's website (http://www.capstead.com) free of charge. Additionally, interested parties may read and copy any materials filed with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Information on the operation of the Public Reference Room is available by calling 1-800-SEC-0330. ITEM 2. PROPERTIES. The Company's headquarters are located in Dallas, Texas in an office leased by the Company. As of December 31, 2002 the Company owned six independent senior living facilities located in five states. For further information, see the Registrant's Annual Report to Stockholders for the year ended December 31, 2002 on pages 34 and 35. ITEM 3. LEGAL PROCEEDINGS. During 1998, twenty-four purported class action lawsuits were filed against the Company and certain of its officers alleging, among other things, that the defendants violated federal securities laws by publicly issuing false and misleading statements and omitting disclosure of material adverse information regarding the Company's business. In March 1999 these actions were consolidated and in July 2000 the court appointed a lead plaintiff group. An amended complaint was filed in October 2000. The amended complaint claims that as a result of alleged improper actions, the market prices of the Company's equity securities were artificially inflated during the period between April 17, 1997 and June 26, 1998. The amended complaint seeks monetary damages in an undetermined amount. In February 2001 the Company responded to this amended complaint with a motion to dismiss all allegations against the Company and the named officers. In April 2001 the plaintiffs responded to the Company's motion to dismiss and the Company filed its reply to the plaintiffs' response in May 2001. On February 6, 2003 the court entered an order stating that it will issue a decision on the motion to dismiss no later than March 7, 2003. The Company believes it has meritorious defenses to the claims and intends to vigorously defend the actions. Based on available information, management believes the resolution of these suits will not have a material adverse effect on the financial position of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 3 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information required by this item regarding the market price of, dividends on, and number of holders of the Registrant's common shares is included in the Registrant's Annual Report to Stockholders for the year ended December 31, 2002 on page 28 under the caption "Note 18 - Market and Dividend Information," and is incorporated herein by reference, pursuant to General Instruction G(2). ITEM 6. SELECTED FINANCIAL DATA. The information required by this item is included in the Registrant's Annual Report to Stockholders for the five years ended December 31, 2002 on page 29 under the caption "Selected Financial Data," and is incorporated herein by reference, pursuant to General Instruction G(2). ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information required by this item is included in the Registrant's Annual Report to Stockholders for the year ended December 31, 2002 on pages 30 through 48 under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," and is incorporated herein by reference, pursuant to General Instruction G(2). ITEM 7.a. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS. The information required by this item is included in the Registrant's Annual Report to Stockholders for the year ended December 31, 2002 on pages 30 through 48 under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," and is incorporated herein by reference, pursuant to General Instruction G(2). ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The information required by this item is included in the Registrant's Annual Report to Stockholders for the year ended December 31, 2002 on pages 3 through 28, and is incorporated herein by reference, pursuant to General Instruction G(2). ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by this item is included in the Registrant's 2003 definitive Proxy Statement on pages 4 through 6 under the captions "Election of Directors," on page 9 under the caption "Executive Officers," and on page 19 under the caption "Compliance with Section 16(a) of the Securities Exchange Act of 1934," all of which are incorporated herein by reference pursuant to General Instruction G(3). 4 ITEM 11. EXECUTIVE COMPENSATION. The information required by this item is included in the Registrant's 2003 definitive Proxy Statement on pages 10 and 11 under the caption "Executive Compensation," which is incorporated herein by reference pursuant to General Instruction G(3). ITEM 12. SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS. The information required by this item is included in the Registrant's 2003 definitive Proxy Statement on page 12 under the caption "Equity Compensation Plans" and pages 18 and 19 under the caption "Security Ownership of Management and Certain Beneficial Owners," which is incorporated herein by reference pursuant to General Instruction G(3). ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this item is included in the Registrant's 2003 definitive Proxy Statement on page 20 under the caption "Certain Relationships and Related Transactions," which is incorporated herein by reference pursuant to General Instruction G(3). ITEM 14. DISCLOSURE CONTROLS AND PROCEDURES As of December 31, 2002, an evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer ("CEO") and Executive Vice President - Finance ("CFO"), of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of December 31, 2002. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to December 31, 2002. 5 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) Documents filed as part of this report: 1. The following consolidated financial statements of the Company, included in the 2002 Annual Report to Stockholders, are incorporated herein by reference:
PAGE ---- Consolidated Statements of Operations - Three Years Ended December 31, 2002................................................. * Consolidated Balance Sheets - December 31, 2002 and 2001.............................. * Consolidated Statements of Stockholders' Equity and Preferred Stock Subject to Repurchase - Three Years Ended December 31, 2002......................... * Consolidated Statements of Cash Flows - Three Years Ended December 31, 2002................................................. * Notes to Consolidated Financial Statements - December 31, 2002........................ *
2. Financial Statement Schedules - All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. * Incorporated herein by reference from the Company's Annual Report to Stockholders for the year ended December 31, 2002, filed herewith as Exhibit 13. 3. Exhibits: EXHIBIT NUMBER 1.1 Underwriting Agreement dated November 26, 2001 by and between Fortress and Bear, Stearns & Co. Inc. to sell 1,000,000 shares Capstead common stock held by Fortress(4) 1.2 Sales Agreement dated August 20, 2001 by and between Capstead and RCG Equity Finance, a division of Ramius Securities, LLC, for the issuance of up to 875,000 common shares and 1,000,000 Series B preferred shares(6) 3.1 Charter, including Articles of Incorporation, Articles Supplementary for each series of preferred stock and all other amendments to such Articles of Incorporation(5) 3.2 Amended and Restated Bylaws(4) 10.01 1990 Directors' Stock Option Plan(1) 10.02 1994 Flexible Long-Term Incentive Plan, as amended (7) 10.03 1994 Capstead Inc. Restricted Stock Plan(2) 10.04 Deferred Compensation Plan(2) 10.05 1996 Incentive Bonus Plan, as amended(5) 6 PART IV ITEM 15. -- CONTINUED 3. Exhibits (continued): EXHIBIT NUMBER ------ 10.06 1997 Flexible Long Term Incentive Plan(3) 10.07 Management Contract between Capstead and Fortress, as amended(7) 12 Computation of ratio of earnings to combined fixed charges and preferred stock dividends* 13 Portions of the Company's Annual Report to Stockholders for the year ended December 31, 2002* 21 List of subsidiaries of the Company* 23 Consent of Ernst & Young LLP, Independent Auditors* 99.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* (1) Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 33-40017) dated April 29, 1991 (2) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 (3) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1997 (4) Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 333-63358) dated June 19, 2001 (5) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2001 (6) Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 333-68424) dated August 27, 2001 (7) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 * Filed herewith (b) Reports on Form 8-K: Current Report on Form 8-K dated February 6, 2003 to furnish the Company's press release announcing fourth quarter results, record date for annual meeting and accelerated common dividend schedule for 2003. (c) Exhibits - The response to this section of ITEM 15 is submitted as a separate section of this report. (d) Financial Statement Schedules - The response to this section of ITEM 15 is submitted as a separate section of this report. 7 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CAPSTEAD MORTGAGE CORPORATION REGISTRANT Date: March 7, 2003 By: /s/ WESLEY R. EDENS -------------------------------------- Wesley R. Edens Chairman and Chief Executive Officer Date: March 7, 2003 By: /s/ ANDREW F. JACOBS -------------------------------------- Andrew F. Jacobs Executive Vice President - Finance Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated below and on the dates indicated. /s/ WESLEY R. EDENS Chairman, Chief Executive March 7, 2003 - -------------------------------------- Officer and Director (Wesley R. Edens) /s/ ANDREW F. JACOBS Executive Vice President - March 7, 2003 - -------------------------------------- Finance (Andrew F. Jacobs) /s/ ROBERT I. KAUFFMAN Director March 7, 2003 - -------------------------------------- (Robert I. Kauffman) /s/ PAUL M. LOW Director March 7, 2003 - -------------------------------------- (Paul M. Low) /s/ MICHAEL G. O'NEIL Director March 7, 2003 - -------------------------------------- (Michael G. O'Neil) /s/ HOWARD RUBIN Director March 7, 2003 - -------------------------------------- (Howard Rubin) /s/ MARK S. WHITING Director March 7, 2003 - -------------------------------------- (Mark S. Whiting)
8 CERTIFICATIONS I, Wesley R. Edens, certify that: 1. I have reviewed this annual report on Form 10-K of Capstead Mortgage Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 7, 2003 By: /s/ WESLEY R. EDENS ------------------------------------- Wesley R. Edens Chairman and Chief Executive Officer 9 CERTIFICATIONS I, Andrew F. Jacobs, certify that: 1. I have reviewed this annual report on Form 10-K of Capstead Mortgage Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 7, 2003 By: /s/ ANDREW F. JACOBS ---------------------------------- Andrew F. Jacobs Executive Vice President - Finance 10 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 1.1 Underwriting Agreement dated November 26, 2001 by and between Fortress and Bear, Stearns & Co. Inc. to sell 1,000,000 shares Capstead common stock held by Fortress(4) 1.2 Sales Agreement dated August 20, 2001 by and between Capstead and RCG Equity Finance, a division of Ramius Securities, LLC, for the issuance of up to 875,000 common shares and 1,000,000 Series B preferred shares(6) 3.1 Charter, including Articles of Incorporation, Articles Supplementary for each series of preferred stock and all other amendments to such Articles of Incorporation(4) 3.2 Amended and Restated Bylaws(4) 10.01 1990 Directors' Stock Option Plan(1) 10.02 1994 Flexible Long-Term Incentive Plan, as amended(7) 10.03 1994 Capstead Inc. Restricted Stock Plan(2) 10.04 Deferred Compensation Plan(2) 10.05 1996 Incentive Bonus Plan, as amended(5) 10.06 1997 Flexible Long Term Incentive Plan(3) 10.07 Management Contract between Capstead and Fortress, as amended(7) 12 Computation of ratio of earnings to combined fixed charges and preferred stock dividends* 13 Portions of the Company's Annual Report to Stockholders for the year ended December 31, 2002* 21 List of subsidiaries of the Company* 23 Consent of Ernst & Young LLP, Independent Auditors* 99.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
(1) Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 33-40017) dated April 29, 1991 (2) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 (3) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1997 (4) Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 333-63358) dated June 19, 2001 (5) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2001 (6) Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 333-68424) dated August 27, 2001 (7) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 * Filed herewith EX-12 3 d03478exv12.txt COMPUTATION OF RATIO OF EARNINGS TO CHARGES EXHIBIT 12 CAPSTEAD MORTGAGE CORPORATION COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS (IN THOUSANDS, EXCEPT RATIOS) (UNAUDITED) (a) Computation of ratio of earnings to combined fixed charges and preferred stock dividends (including CMO debt):
YEAR ENDED DECEMBER 31 ----------------------------------------------------------------------- 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ---------- Fixed charges $ 169,148 $ 362,327 $ 540,605 $ 502,933 $ 673,233 Preferred stock dividends 20,362 20,446 24,260 22,556 22,342 ---------- ---------- ---------- ---------- ---------- Combined fixed charges and preferred stock dividends $ 189,510 $ 382,773 $ 564,865 $ 525,489 $ 695,575 ========== ========== ========== ========== ========== Fixed charges $ 169,148 $ 362,327 $ 540,605 $ 502,933 $ 673,233 Net income (loss) 96,123 106,276 (51,486) 57,909 (234,764) ---------- ---------- ---------- ---------- ---------- $ 265,271 $ 468,603 $ 489,119 $ 560,842 $ 438,469 ========== ========== ========== ========== ========== Ratio of earnings to combined fixed charges and preferred stock dividends 1.40:1 1.22:1 0.87:1 1.07:1 0.63:1 ========== ========== ========== ========== ==========
(b) Computation of ratio of earnings to combined fixed charges and preferred stock dividends (excluding CMO debt):
YEAR ENDED DECEMBER 31 ----------------------------------------------------------------------- 2002 2001 2000 1999 1998 ---------- ---------- ---------- ---------- ---------- Fixed charges $ 53,079 $ 164,422 $ 303,126 $ 232,852 $ 332,985 Preferred stock dividends 20,362 20,446 24,260 22,556 22,342 ---------- ---------- ---------- ---------- ---------- Combined fixed charges and preferred stock dividends $ 73,441 $ 184,868 $ 327,386 $ 255,408 $ 355,327 ========== ========== ========== ========== ========== Fixed charges $ 53,079 $ 164,422 $ 303,126 $ 232,852 $ 332,985 Net income (loss) 96,123 106,276 (51,486) 57,909 (234,764) ---------- ---------- ---------- ---------- ---------- $ 149,202 $ 270,698 $ 251,640 $ 290,761 $ 98,221 ========== ========== ========== ========== ========== Ratio of earnings to combined fixed charges and preferred stock dividends 2.03:1 1.46:1 0.77:1 1.14:1 0.28:1 ========== ========== ========== ========== ==========
EX-13 4 d03478exv13.txt PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS EXHIBIT 13 CAPSTEAD MORTGAGE CORPORATION PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 2002 CAPSTEAD MORTGAGE CORPORATION REPORT OF INDEPENDENT AUDITORS Stockholders and Board of Directors Capstead Mortgage Corporation We have audited the accompanying consolidated balance sheets of Capstead Mortgage Corporation as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity and preferred stock subject to repurchase, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Capstead Mortgage Corporation at December 31, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. /s/ ERNST & YOUNG LLP Dallas, Texas January 31, 2003 CAPSTEAD MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
YEAR ENDED DECEMBER 31 ----------------------------------------- 2002 2001 2000 - ------------------------------------------------------- ----------- ----------- ----------- INTEREST INCOME: Mortgage securities and similar investments $ 150,302 $ 274,480 $ 349,533 CMO collateral and investments 114,353 198,216 237,052 ----------- ----------- ----------- Total interest income 264,655 472,696 586,585 ----------- ----------- ----------- INTEREST AND RELATED EXPENSE: Repurchase arrangements and similar borrowings 48,329 164,422 303,126 CMO borrowings 116,069 197,905 237,479 Mortgage insurance and other 596 990 1,545 ----------- ----------- ----------- Total interest and related expense 164,994 363,317 542,150 ----------- ----------- ----------- Net margin on financial assets 99,661 109,379 44,435 ----------- ----------- ----------- REAL ESTATE LEASE INCOME (affiliated) 8,170 -- -- ----------- ----------- ----------- REAL ESTATE-RELATED EXPENSE: Interest 4,750 -- -- Depreciation 2,543 -- -- ----------- ----------- ----------- Total real estate-related expense 7,293 -- -- ----------- ----------- ----------- Net margin on real estate held for lease 877 -- -- ----------- ----------- ----------- OTHER REVENUE (EXPENSE): Gain (loss) on asset sales 4,725 7,956 (70,173) Impairment on financial assets -- -- (19,088) Severance costs -- -- (3,607) CMO administration and other revenue 2,429 3,705 3,484 Management and affiliate incentive fee (5,986) (9,422) (389) Other operating expense (5,583) (5,342) (6,148) ----------- ----------- ----------- Total other revenue (expense) (4,415) (3,103) (95,921) ----------- ----------- ----------- NET INCOME (LOSS) $ 96,123 $ 106,276 $ (51,486) =========== =========== =========== Net income (loss) $ 96,123 $ 106,276 $ (51,486) Less preferred share dividends (20,362) (20,446) (24,260) ----------- ----------- ----------- Net income (loss) available to common stockholders $ 75,761 $ 85,830 $ (75,746) =========== =========== =========== Net income (loss) per common share: Basic $ 5.47 $ 6.43 $ (6.59) Diluted 4.85 5.68 (6.59)
See accompanying notes to consolidated financial statements. CAPSTEAD MORTGAGE CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts)
DECEMBER 31 ---------------------------------- 2002 2001 - ------------------------------------------------------------------------------------- --------------- --------------- ASSETS Mortgage securities and similar investments ($2.1 billion pledged under repurchase arrangements) $ 2,431,519 $ 3,455,219 CMO collateral and investments 1,083,421 2,262,305 --------------- --------------- 3,514,940 5,717,524 Real estate held for lease, net of accumulated depreciation 137,122 -- Receivables and other assets 55,863 60,261 Cash and cash equivalents 59,003 117,640 --------------- --------------- $ 3,766,928 $ 5,895,425 =============== =============== LIABILITIES Repurchase arrangements and similar borrowings $ 2,145,656 $ 3,207,068 Collateralized mortgage obligations 1,074,779 2,245,015 Borrowings secured by real estate 120,400 -- Incentive fee payable to management and affiliate 5,986 9,422 Common dividend payable 116,585 20,794 Accounts payable and accrued expenses 4,944 8,398 --------------- --------------- 3,468,350 5,490,697 --------------- --------------- STOCKHOLDERS' EQUITY Preferred stock - $0.10 par value; 100,000 authorized $1.60 Cumulative Preferred Stock, Series A, 219 and 273 shares issued and outstanding at December 31, 2002 and 2001, respectively ($3,587 aggregate liquidation preference) 3,058 3,821 $1.26 Cumulative Convertible Preferred Stock, Series B, 15,820 and 15,842 shares issued and outstanding at December 31, 2002 and 2001, respectively ($180,026 aggregate liquidation preference) 176,708 176,961 Common stock - $0.01 par value; 100,000 shares authorized; 13,962 and 13,862 shares issued and outstanding at December 31, 2002 and 2001, respectively 140 139 Paid-in capital 458,919 559,571 Accumulated deficit (387,718) (387,718) Accumulated other comprehensive income 47,471 51,954 --------------- --------------- 298,578 404,728 --------------- --------------- $ 3,766,928 $ 5,895,425 =============== ===============
See accompanying notes to consolidated financial statements. CAPSTEAD MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND PREFERRED STOCK SUBJECT TO REPURCHASE (In thousands, except per share amounts)
PREFERRED ACCUMULATED STOCK OTHER TOTAL SUBJECT TO PREFERRED COMMON PAID-IN ACCUMULATED COMPREHENSIVE STOCKHOLDERS' REPURCHASE STOCK STOCK CAPITAL DEFICIT INCOME (LOSS) EQUITY - -------------------------------------- ---------- --------- --------- --------- --------- --------- ------------- BALANCE AT JANUARY 1, 2000 $ 50,584 $ 191,476 $ 142 $ 770,044 $(304,568) $ (93,288) $ 563,806 Net loss -- -- -- -- (51,486) -- (51,486) Other comprehensive income -- -- -- -- -- 112,733 112,733 Cash dividends: Common ($1.42 per share) -- -- -- -- (16,568) -- (16,568) Preferred -- -- -- -- (25,546) -- (25,546) Conversion of preferred stock (25,210) -- 13 25,197 -- -- 25,210 Additions to capital (164) -- 1 144 -- -- 145 Capital stock repurchases -- (9,236) (30) (54,645) 1,286 -- (62,625) --------- --------- --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 2000 25,210 182,240 126 740,740 (396,882) 19,445 545,669 Net income -- -- -- -- 106,276 -- 106,276 Other comprehensive income -- -- -- -- -- 32,509 32,509 Cash dividends: Common - regular ($5.54 per share) -- -- -- -- (76,666) -- (76,666) Common - special ($14.60 per share) -- -- -- (201,236) -- -- (201,236) Preferred -- -- -- -- (20,446) -- (20,446) Conversion of preferred stock (25,210) (1,458) 14 26,654 -- -- 25,210 Additions to capital -- -- 1 731 -- -- 732 Capital stock repurchases -- -- (2) (7,318) -- -- (7,320) --------- --------- --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 2001 -- 180,782 139 559,571 (387,718) 51,954 404,728 --------- Net income -- -- -- -- 96,123 -- 96,123 Other comprehensive loss: Change in unrealized gain on cash flow hedges, net -- -- -- -- -- (311) (311) Change in unrealized gain on debt securities, net -- -- -- -- -- (4,172) (4,172) --------- Total comprehensive income 91,640 Cash dividends: Common - regular ($5.56 per share) -- -- -- (1,607) (75,761) -- (77,368) Common - special ($7.19 per share) -- -- -- (100,389) -- -- (100,389) Preferred -- -- -- -- (20,362) -- (20,362) Conversion of preferred stock -- (1,016) 1 1,015 -- -- -- Additions to capital -- -- -- 329 -- -- 329 --------- --------- --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 2002 $ -- $ 179,766 $ 140 $ 458,919 $(387,718) $ 47,471 $ 298,578 ========= ========= ========= ========= ========= ========= =========
See accompanying notes to consolidated financial statements. CAPSTEAD MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
YEAR ENDED DECEMBER 31 ----------------------------------------------- 2002 2001 2000 - --------------------------------------------------------------------------- ------------- ------------- ------------- OPERATING ACTIVITIES: Net income (loss) $ 96,123 $ 106,276 $ (51,486) Noncash items: Amortization of discount and premium 22,936 31,263 17,486 Depreciation and other amortization 4,081 1,223 986 Impairment on financial assets -- -- 19,088 Recognition of rent abatement (3,223) -- -- (Gain) loss on asset sales (4,725) (7,956) 70,173 Change in incentive fee payable to management and affiliate (3,436) 9,422 -- Net change in receivables, other assets, accounts payable and accrued expenses 1,714 (3,541) (370) ------------- ------------- ------------- Net cash provided by operating activities 113,470 136,687 55,877 ------------- ------------- ------------- INVESTING ACTIVITIES: Purchases of mortgage securities and similar investments (184,176) (226,557) (2,366,925) Purchase of real estate (18,828) -- -- Purchases of CMO collateral and investments -- -- (235,999) Principal collections on mortgage securities and similar investments 1,134,295 1,705,893 982,118 Proceeds from asset sales 97,003 576,554 1,404,321 CMO collateral: Principal collections 1,131,708 758,423 423,487 Decrease in accrued interest receivable 7,028 5,808 2,972 ------------- ------------- ------------- Net cash provided by investing activities 2,167,030 2,820,121 209,974 ------------- ------------- ------------- FINANCING ACTIVITIES: Increase (decrease) in repurchase arrangements and similar borrowings (1,061,412) (1,697,564) 32,240 Borrowings secured by real estate: Issuance of borrowings 100,841 -- -- Principal payments on borrowings (101,278) -- -- CMO borrowings: Issuance of securities -- -- 235,999 Principal payments on securities (1,168,682) (862,311) (430,705) Decrease in accrued interest payable (6,468) (5,515) (2,245) Capital stock transactions 189 (207,960) (62,752) Dividends paid (102,327) (81,628) (43,653) ------------- ------------- ------------- Net cash used in financing activities (2,339,137) (2,854,978) (271,116) ------------- ------------- ------------- Net change in cash and cash equivalents (58,637) 101,830 (5,265) Cash and cash equivalents at beginning of year 117,640 15,810 21,075 ------------- ------------- ------------- Cash and cash equivalents at end of year $ 59,003 $ 117,640 $ 15,810 ============= ============= =============
See accompanying notes to consolidated financial statements. CAPSTEAD MORTGAGE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002 NOTE 1 -- BUSINESS Capstead Mortgage Corporation operates as a real estate investment trust ("REIT") earning income from investing in real estate-related assets on a leveraged basis and from other investment strategies. These investments currently include, but are not limited to, single-family residential adjustable-rate mortgage ("ARM") securities issued by government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities"). Capstead has also made limited investments in credit-sensitive commercial real estate-related assets, including the direct ownership of real estate (see NOTE 6), intended to produce attractive returns due largely to a higher risk of default and reduced liquidity compared to Agency Securities. The Company continues to evaluate suitable real estate-related investments, which may include more credit-sensitive assets. Management believes that such investments, when combined with the prudent use of leverage, can provide attractive returns over the long term with less sensitivity to changes in interest rates. Capstead's investment portfolios declined during 2002 and 2001 primarily because of high levels of mortgage prepayments and a lack of suitable investment opportunities. Consequently, Capstead has returned a significant portion of its equity capital to its common stockholders the last two years. To the extent proceeds of runoff or asset sales are not reinvested, or cannot be reinvested, at a rate of return at least equal to the rate previously earned on that capital, earnings may decline. The future size and composition of Capstead's investment portfolios will depend on market conditions, including levels of mortgage prepayments and the availability on a timely basis of suitable investments at attractive pricing. NOTE 2 -- ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Capstead Mortgage Corporation ("Capstead") and its subsidiaries, including special-purpose finance and real estate subsidiaries (collectively, the "Company"). Intercompany balances and transactions have been eliminated. Substantially all of the assets of the special-purpose finance subsidiaries are pledged to secure collateralized mortgage obligations ("CMOs") and are not available for the satisfaction of general claims of Capstead. Similarly, real estate held for lease is owned by special-purpose real estate subsidiaries and pledged to secure related borrowings and is not available for the satisfaction of general claims of Capstead. Capstead has no responsibility for CMOs or borrowings secured by real estate beyond the assets pledged as collateral. CAPSTEAD MORTGAGE CORPORATION USE OF ESTIMATES The use of estimates is inherent in the preparation of financial statements in conformity with accounting principles generally accepted in the United States. The amortization of premiums and discounts on mortgage assets and CMOs is based on estimates of future prepayments on underlying mortgage loans, which are impacted by future changes in interest rates and other factors beyond the control of management. Actual results could differ from those estimates, which could adversely affect profitability. Similarly, depreciation on real estate is based on estimates of the useful lives of buildings, equipment and fixtures, which could be affected by significant adverse events or changes in circumstances and potentially lead to impairment charges. Estimated fair values of debt securities have been determined using available market information and appropriate valuation methodologies; however, considerable judgment is required in interpreting market data to develop these estimates. In addition, fair values fluctuate on a daily basis. Accordingly, estimates of fair value as of the balance sheet dates are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on estimated fair values, which would affect Accumulated other comprehensive income in stockholders' equity and the calculation of the Management and affiliate incentive fee. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current year presentation. FINANCIAL ASSETS Financial assets held in the form of asset-backed securities are debt securities. Management determines the appropriate classification of debt securities at the time of purchase and periodically reevaluates such designation. Debt securities may be classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are stated at fair value with unrealized gains (losses) reported as a separate component of Accumulated other comprehensive income in stockholders' equity. Financial assets held in the form of whole loans are carried at their unpaid principal balances, net of unamortized discount or premium. The Company may, from time to time, hold loans for sale. Such loans are carried at the lower of cost or market on an aggregate basis. Transfers from loans for sale to loans for investment are recorded at the lower of cost or market. Interest is recorded as income when earned. Any premium or discount is recognized as an adjustment to interest income by the interest method over the life of the related financial asset. Realized gains and losses are included in Other revenue (expense). The cost of financial assets sold is based on the specific identification method. Unrealized gains and losses are not amortized to income; however, if a decline in fair value of an individual financial asset below amortized cost basis occurs that is determined to be other than temporary, the difference between amortized cost and fair value is included in Other revenue (expense) as an impairment charge. CAPSTEAD MORTGAGE CORPORATION REAL ESTATE Land, buildings, equipment and fixtures are carried at cost less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the depreciable assets (40 years for buildings and five years for equipment and fixtures). Should a significant adverse event or change in circumstances occur, management will assess if the values of the Company's real estate properties have become impaired. A property is considered impaired only if estimated operating cash flows (undiscounted and without interest charges) of a property over its remaining useful life is less than its net carrying value. If impaired, the difference between a property's net carrying value and its fair value would be included in Other revenue (expense) as an impairment charge. No impairment charges have been taken as of December 31, 2002. REAL ESTATE LEASE INCOME RECOGNITION Base rents are recognized on a straight-line basis over the term of the related leases. Base rent escalations, when present, are recognized when earned if dependent upon unknown factors such as future increases in the Consumer Price Index. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less when purchased. DERIVATIVE FINANCIAL INSTRUMENTS The Company may from time to time acquire derivative financial instruments ("Derivatives") for risk management purposes. These may include interest rate floors, swaps and caps, U.S. Treasury futures contracts and options, written options on financial assets or various other Derivatives available in the marketplace that are compatible with the Company's risk management objectives. The Company has made limited use of Derivatives during the three years ended December 31, 2002. Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") established new accounting and reporting standards for Derivatives and hedging activities. This includes the recognition of all Derivatives, including certain Derivatives not previously afforded accounting recognition, as either assets or liabilities on the balance sheets and measurement of those instruments at fair value. The Company adopted this statement January 1, 2001 and recognized in Other comprehensive income (loss) as cash flow hedge instruments certain call rights on securitizations previously issued by the Company that were originally accounted for as sales. These call rights, which were subsequently all exercised, allowed Capstead to acquire a modest amount of adjustable-rate mortgage-backed securities at par value. The fair value of these call rights was based on the discounted fair value of the underlying loans in excess of par, less transaction costs. As such, changes in the value of the call rights were 100% correlated to changes in value of the underlying loans, excluding the effects of time value which was recorded in Other revenue (expense). Upon exercise, the underlying loans were recorded at par and the value of the related call right was reclassified as a loan premium and CAPSTEAD MORTGAGE CORPORATION is being amortized to Interest income as a yield adjustment. The related amount recorded in Other comprehensive income (loss) is also amortized to Interest income concurrently with the loan premium. Included in Receivables and other assets are interest rate caps acquired in connection with the assumption and subsequent refinancing of tax-exempt bonds secured by real estate held for lease (see NOTE 9). Changes in value of the caps are considered 100% correlated to changes in expected future cash flows of the variable-rate bonds, excluding the effects of time value. Accordingly, changes in time value are recorded in Other revenue (expense) and other changes in value are recorded in Other comprehensive income (loss). BORROWINGS CMOs, borrowings under repurchase arrangements and other borrowings are carried at their unpaid principal balances, net of unamortized discounts and premiums. Discounts and premiums, as well as debt issue costs which are recorded in Receivables and other assets, are recognized as adjustments to Interest and related expense by the interest method over the expected term of the related borrowings. INCOME TAXES Income taxes are accounted for using the liability method, and deferred income tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. Capstead and its qualified REIT subsidiaries have elected to be taxed as a REIT. As a result of this election, the Company is not taxed on taxable income distributed to stockholders if certain REIT qualification tests are met. It is Capstead's policy to distribute 100% of taxable income of the REIT within the time limits prescribed by the Internal Revenue Code (the "Code"), which may extend into the subsequent taxable year. Accordingly, no provision has been made for income taxes for Capstead and its qualified REIT subsidiaries. Capstead may find it advantageous from time to time to elect non-REIT subsidiary status for certain of its qualified REIT subsidiaries. All taxable income of Capstead's non-REIT subsidiaries is subject to federal and state income taxes, where applicable. MANAGEMENT AND AFFILIATE INCENTIVE FEE Members of management, employees and an affiliate of Fortress Investment Group LLC participate in an incentive compensation program established by the members of the Board of Directors that are independent of Fortress Investment Group LLC and its affiliates (together, referred to as "Fortress"). Fortress is the Company's controlling stockholder, and Wesley R. Edens, its chairman of the board, is also Capstead's Chairman of the Board and Chief Executive Officer (see NOTE 15). Under the terms of the program, incentive fee amounts are determined based on a 10% participation in the "modified total return" of Capstead in excess of a 10% benchmark return, multiplied by the Company's beginning "modified common book value." Modified total return under the program is measured as the change in modified common book value per share during the year, together with common dividends per CAPSTEAD MORTGAGE CORPORATION share. For the three years in the period ended December 31, 2002, modified common book value was determined by deducting from total equity the recorded value of preferred equity and unrealized losses on assets classified as held-to-maturity, and adding back incentive fee accruals. STOCK-BASED COMPENSATION As more fully described in NOTE 13, the Company accounts for stock-based awards for employees and directors under the recognition and measurement principles of APB No. 25, "Accounting for Stock Issued to Employees," and related Interpretations ("APB25"). Under APB25 compensation cost for stock-based awards for employees and directors is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount to be paid to acquire the stock and is recognized in Other operating expense as the awards vest and restrictions lapse. The increase in total stock-based compensation expense if determined under the fair value-based methodology prescribed under Statement of Financial Accounting Standards No. 123 "Accounting for Stock-based Compensation" ("SFAS 123") would have been $84,000, $88,000 and $108,000 in 2002, 2001 and 2000, respectively, which would have had no effect on reported net income (loss) per common share in 2002 and a one cent per common share effect in 2001 and 2000. NET INCOME (LOSS) PER COMMON SHARE Basic net income (loss) per common share is computed by dividing net income (loss), after deducting preferred share dividends, by the weighted average number of common shares outstanding. Diluted net income (loss) per common share is computed by dividing net income (loss), after deducting preferred share dividends for antidilutive convertible preferred shares, by the weighted average number of common shares and common share equivalents outstanding, giving effect to dilutive stock options and dilutive convertible preferred shares. For dilutive net income per share purposes, the Series A and B preferred shares are considered dilutive whenever annualized basic net income per share exceeds each Series' annualized dividend divided by the conversion rate applicable for that period. The Series A preferred shares were dilutive throughout 2002 and 2001. The Series B preferred shares became dilutive July 2, 2001 after a new conversion rate went into effect, even though few actual Series B conversions occurred because it was uneconomical to convert at the market prices of the common shares and Series B preferred shares in effect during these periods. CAPSTEAD MORTGAGE CORPORATION NOTE 3 -- CALCULATION OF NET INCOME (LOSS) PER COMMON SHARE The components of the computation of basic and diluted net income (loss) per share were as follows (in thousands, except per share data):
YEAR ENDED DECEMBER 31 ----------------------------------------------- 2002 2001 2000 - ----------------------------------------------------------------- ------------- ------------- ------------- NUMERATOR FOR BASIC NET INCOME (LOSS) PER COMMON SHARE: Net income (loss) $ 96,123 $ 106,276 $ (51,486) Less preferred share dividends: Series A (408) (485) (598) Series B (19,954) (19,961) (20,322) Series B repurchase amount less than book value* -- -- 1,286 Series C and D -- -- (4,626) ------------- ------------- ------------- $ 75,761 $ 85,830 $ (75,746) ============= ============= ============= DENOMINATOR FOR BASIC NET INCOME (LOSS) PER COMMON SHARE: Weighted average common shares outstanding 13,858 13,351 11,487 ============= ============= ============= BASIC NET INCOME (LOSS) PER COMMON SHARE $ 5.47 $ 6.43 $ (6.59) ============= ============= ============= NUMERATOR FOR DILUTED NET INCOME (LOSS) PER COMMON SHARE: Net income (loss) $ 96,123 $ 106,276 $ (51,486) Less cash dividends paid on antidilutive convertible preferred shares: Series A -- -- (598) Series B ** -- (9,981) (20,322) Series B repurchase amount less than book value* -- -- 1,286 Series C (converted into common shares May 4, 2001) -- -- (3,012) Series D (converted into common shares December 28, 2000) -- -- (1,614) ------------- ------------- ------------- $ 96,123 $ 96,295 $ (75,746) ============= ============= ============= DENOMINATOR FOR DILUTED NET INCOME (LOSS) PER COMMON SHARE: Weighted average common shares outstanding 13,858 13,351 11,487 Net effect of dilutive stock options 57 84 -- Net effect of dilutive convertible preferred shares: Series A 260 241 -- Series B ** 5,652 2,827 -- Series C and D -- 453 -- ------------- ------------- ------------- 19,827 16,956 11,487 ============= ============= ============= DILUTED NET INCOME (LOSS) PER COMMON SHARE $ 4.85 $ 5.68 $ (6.59) ============= ============= =============
* Included as a component of the Series B preferred share dividends in the calculation of both basic and diluted net income (loss) per common share is the difference between repurchase amounts and the Series B preferred shares book value of $11.17 per share. ** Reflects the Series B preferred shares as antidilutive prior to a July 2, 2001 change in conversion rates. NOTE 4 -- MORTGAGE SECURITIES AND SIMILAR INVESTMENTS The Company classifies its mortgage securities and similar investments by collateral type and interest rate characteristics. Agency Securities are AAA-rated and are considered to have limited credit risk. Non-agency securities consist of private mortgage pass-through securities backed primarily by single-family residential mortgage loans whereby the related CAPSTEAD MORTGAGE CORPORATION credit risk of the underlying loans is borne by AAA-rated private mortgage insurers ("Non-agency Securities"). Commercial mortgage securitizations generally have senior, mezzanine and subordinate classes of bonds with the lower bond classes providing credit enhancement to the more senior classes. Commercial mortgage-backed securities ("CMBS") held by the Company as of December 31, 2002 are mezzanine classes and therefore carry credit risk associated with the underlying pools of commercial mortgage loans that is mitigated by subordinate bonds held by other investors. Commercial loans held by the Company as of December 31, 2002 consist of a loan to a joint venture that holds commercial real estate. The maturity of mortgage securities is directly affected by the rate of principal prepayments on the underlying loans. Mortgage securities and similar investments and the related weighted average interest rates were as follows (dollars in thousands):
AVERAGE AVERAGE PRINCIPAL PREMIUMS CARRYING COUPON EFFECTIVE BALANCE (DISCOUNTS) BASIS AMOUNT (a) RATE (b) RATE (b) -------------- -------------- -------------- -------------- -------------- -------------- DECEMBER 31, 2002 Agency Securities: Fannie Mae/Freddie Mac: Fixed-rate $ 3,628 $ 21 $ 3,649 $ 3,788 10.00% 9.48% LIBOR/CMT ARMs 1,120,142 16,376 1,136,518 1,162,197 4.99 5.04 COFI ARMs 126,356 (3,655) 122,701 128,475 4.20 5.30 Ginnie Mae ARMs 881,911 9,767 891,678 904,470 5.36 5.25 -------------- -------------- -------------- ------------- 2,132,037 22,509 2,154,546 2,198,930 5.10 5.16 Non-agency Securities (c) 83,073 713 83,786 85,290 5.12 5.62 CMBS (c) 107,989 (309) 107,680 107,762 3.04 3.96 Commercial loans (c) 39,505 32 39,537 39,537 8.50 9.03 -------------- -------------- -------------- ------------- $ 2,362,604 $ 22,945 $ 2,385,549 $ 2,431,519 5.07 5.17 ============== ============== ============== ============= DECEMBER 31, 2001 Agency Securities: Fannie Mae/Freddie Mac: Fixed-rate $ 5,706 $ 34 $ 5,740 $ 5,981 10.00% 9.29% Medium-term 40,559 (149) 40,410 41,544 6.19 6.44 LIBOR/CMT ARMs 1,543,867 25,286 1,569,153 1,593,115 6.88 6.59 COFI ARMs 167,080 (4,839) 162,241 168,856 5.31 6.45 Ginnie Mae ARMs 1,368,551 14,460 1,383,011 1,398,908 6.37 6.40 -------------- -------------- -------------- ------------- 3,125,763 34,792 3,160,555 3,208,404 6.57 6.49 Non-agency securities (c) 73,040 373 73,413 74,839 6.94 7.58 CMBS (c) 172,071 (380) 171,691 171,976 3.69 6.46 -------------- -------------- -------------- ------------- $ 3,370,874 $ 34,785 $ 3,405,659 $ 3,455,219 6.43 6.52 ============== ============== ============== =============
(a) Includes unrealized gains and losses for securities classified as available-for-sale, if applicable (see NOTE 10). (b) Average Coupon Rate is presented as of the indicated balance sheet date. Average Effective Rate is presented for the year then ended, calculated including the amortization of premiums and discounts, mortgage insurance costs on non-agency securities and excluding unrealized gains and losses. (c) As of the indicated dates, these portfolios consisted nearly exclusively of adjustable-rate investments. Fixed-rate investments have fixed rates of interest and initial expected weighted average lives of greater than five years. Medium-term investments either (i) have fixed rates of interest and initial expected weighted average lives of five years or less, (ii) are secured by mortgage loans that have an initial fixed-rate period of three or five years after origination and then adjust annually based on a specified margin over the one-year Constant Maturity U.S. Treasury Note Rate ("One-year CMT"), or (iii) are secured by mortgage loans that have initial interest rates that adjust one time, approximately three or five years after origination, CAPSTEAD MORTGAGE CORPORATION based on a specified margin over Fannie Mae yields for 30-year, fixed-rate commitments at the time of adjustment. Adjustable-rate investments have interest rates that adjust at least annually to more current interest rates. For instance, mortgage loans underlying ARM securities either (i) adjust annually based on a specified margin over One-year CMT, (ii) adjust semiannually based on a specified margin over the six-month London Interbank Offered Rate ("LIBOR"), or (iii) adjust monthly based on a specific margin over an index such as LIBOR or the Cost of Funds Index as published by the Eleventh District Federal Reserve Bank ("COFI"). In addition, the terms of most ARM loans limit the amount of such adjustments during any single interest rate adjustment period and over the life of the loan. Adjustable-rate investments also include investments previously classified as medium-term that have begun adjusting annually based on a specified margin over One-year CMT. CMBS and commercial loans held as of December 31, 2002 adjust monthly based on a specified margin over 30-day LIBOR. In connection with modifying its investment strategy in April 2000, the Company sold $1.4 billion of fixed-rate and medium-term mortgage investments and designated for sale another $700 million of primarily medium-term securities, incurring charges of $70.9 million included in Gain (loss) on asset sales, and $19.1 million included in Impairment on financial assets. During 2001, $451 million of medium-term securities previously written down as impaired were sold for a gain of $5.9 million. Remaining securities written down in 2000 were carried at an unrealized gain of $5.8 million at December 31, 2002. In connection with the formation of private mortgage pass-through securities prior to 1995, the Company was required to establish reserve funds available to pay special hazard (e.g. earthquake or mudslide-related losses) or certain bankruptcy costs. The private mortgage pass-through securities were subsequently held as Non-agency Securities, pledged as CMO collateral or sold to third parties. As of December 31, 2002, included in Receivables and other assets as restricted cash are $4.9 million in special hazard reserve funds and $1.2 million of bankruptcy reserve funds associated with $75 million and $79 million of loans outstanding, respectively. NOTE 5 -- CMO COLLATERAL AND INVESTMENTS CMO collateral consists of primarily fixed-rate mortgage securities collateralized by single-family residential mortgage loans and related short-term investments, both pledged to secure CMO borrowings ("Pledged CMO Collateral"). All principal and interest on pledged mortgage securities is remitted directly to collection accounts maintained by a trustee. The trustee is responsible for reinvesting those funds in short-term investments. All collections on the pledged mortgage securities and the reinvestment income earned thereon are available for the payment of principal and interest on CMO borrowings. The components of CMO collateral and investments were as follows (in thousands):
DECEMBER 31 ------------------------------- 2002 2001 - --------------------------------------------- -------------- -------------- Pledged CMO Collateral: Pledged mortgage securities $ 1,066,734 $ 2,231,354 Accrued interest receivable 6,325 13,329 -------------- -------------- 1,073,059 2,244,683 Unamortized premium 8,571 14,860 -------------- -------------- 1,081,630 2,259,543 CMO investments 1,791 2,762 -------------- -------------- $ 1,083,421 $ 2,262,305 ============== ==============
CAPSTEAD MORTGAGE CORPORATION Pledged mortgage securities are primarily private mortgage pass-through securities whereby the related credit risk of the underlying loans is borne by AAA-rated private mortgage insurers or subordinated bonds within the related CMO series to which the collateral is pledged. The Company has retained $33,000 of credit risk held in the form of subordinated bonds associated with $76 million of Pledged CMO Collateral outstanding as of December 31, 2002. CMO investments currently consist of a subordinated bond retained by the Company in connection with a 1993 mortgage loan sale that is available to pay special hazard or certain bankruptcy costs associated with $33 million of loans outstanding as of December 31, 2002. The weighted average effective interest rate for Pledged CMO Collateral and investments was 6.88% and 7.24% during 2002 and 2001, respectively. NOTE 6 -- REAL ESTATE HELD FOR LEASE On May 1, 2002 Capstead acquired six "independent" senior living facilities (wherein the operator of the facility provides the tenants little, if any, medical care) and one skilled nursing facility (collectively, the "Properties"). In October 2002, the skilled nursing facility was sold for cash proceeds of approximately $4.1 million, net of selling costs. No gain or loss was recognized on this transaction. After adjustment for the sale of the skilled nursing facility, the aggregate purchase price of the Properties was $139.7 million including approximately $3.1 million in closing costs and the assumption by Capstead of $19.7 million of related mortgage debt and $101.1 million of tax-exempt bond debt. The Properties were acquired pursuant to purchase agreements initially negotiated and executed by subsidiaries of Brookdale Living Communities, Inc. (collectively with its subsidiaries, "Brookdale") with an affiliate of Apartment Investment Management Company ("AIMCO") and subsequently assigned to Capstead. Concurrent with the acquisition, the Company entered into a long-term "net-lease" arrangement with Brookdale, under which Brookdale is responsible for the ongoing operation and management of the Properties. Brookdale, an owner, operator, developer and manager of senior living facilities, is a majority-owned affiliate of Fortress. The lease arrangement consists of a master lease covering all of the Properties and individual property-level leases (referred to collectively as the "Lease"). The Lease has an initial term of 20 years and provides for two 10-year renewal periods. Beginning at the end of five years, Brookdale will have the option of purchasing all of the Properties from Capstead at the greater of fair value or Capstead's original cost, after certain adjustments. Under the terms of the Lease, Brookdale is responsible for paying all expenses associated with the operation of the Properties, including real estate taxes, other governmental charges, insurance, utilities and maintenance, and an amount representing an attractive cash return on Capstead's equity in the Properties after payment of monthly debt service. Because under the terms of the Lease, Brookdale is responsible for changes in related debt service requirements, earnings from the Company's investment in net-leased real estate are generally not affected by changes in interest rates. After an initial three-month rent concession period, the cash return on Capstead's equity is expected to exceed 15% on an annualized basis and is subject to annual increases based upon increases (capped at 3%) in the Consumer Price Index. The Lease qualifies as an operating lease for financial reporting purposes with future minimum rentals expected to approximate $10 million per year for each of the next five years. Included in Receivables and other assets at December 31, 2002 are $3.2 million in unamortized rent abatements and $1.4 million of other rent receivables from Brookdale. CAPSTEAD MORTGAGE CORPORATION The following table summarizes carrying amounts of the Properties as of December 31, 2002 (in thousands): Land $16,450 Buildings 119,550 Equipment and fixtures 3,600 ---------- 139,600 Accumulated depreciation (2,478) ----------- $137,122 ===========
Concurrent with executing the purchase agreements for the Properties, Brookdale also entered into an agreement with AIMCO to acquire from AIMCO $71.4 million of the tax-exempt bonds secured by the Properties held by a tax-exempt bond fund (the "TEB Fund Bonds") for a purchase price of $60.7 million. With Capstead's May 1, 2002 acquisition of the Properties and assumption of the bonds, Brookdale agreed to release AIMCO from its obligation to deliver the TEB Fund Bonds pursuant to the bond purchase agreement in exchange for which AIMCO paid Brookdale $4.6 million and Brookdale simultaneously entered into a two-year total return swap agreement with respect to the TEB Fund Bonds with a notional swap strike price of $65.4 million. The swap was terminated in November when the bonds were refinanced (see NOTE 9) resulting in a net payment to Brookdale of $6.0 million. The swap counterparty was a financial institution affiliated with the tax-exempt bond fund. NOTE 7 -- REPURCHASE ARRANGEMENTS AND SIMILAR BORROWINGS Borrowings made under uncommitted repurchase arrangements with investment banking firms pursuant to which the Company pledges Agency and Non-agency Securities as collateral generally have maturities of less than 31 days. Repurchase arrangements with CMBS pledged as collateral generally have longer initial maturities and may feature renewal options. Commercial bank borrowings at December 31, 2002 consist of an adjustable-rate loan that matures in January 2005 secured by a commercial loan investment. The terms and conditions of repurchase arrangements and similar borrowings are negotiated on a transaction-by-transaction basis. Repurchase arrangements and similar borrowings, classified by type of collateral, maturities and related weighted average interest rates for the dates indicated, were as follows (dollars in thousands):
DECEMBER 31, 2002 DECEMBER 31, 2001 ------------------------------- ------------------------------- BORROWINGS AVERAGE BORROWINGS AVERAGE OUTSTANDING RATE OUTSTANDING RATE - -------------------------------------------------- -------------- -------------- -------------- -------------- Agency Securities (less than 31 days) $ 1,980,050 1.34% $ 2,999,860 1.88% Non-agency Securities (less than 31 days) 37,677 1.47 55,602 2.05 CMBS (greater than 90 days) 98,184 1.62 151,606 2.23 -------------- -------------- 2,115,911 1.36 3,207,068 1.90 Commercial bank borrowings 29,745 3.91 -- -- -------------- -------------- $ 2,145,656 1.39 $ 3,207,068 1.90 ============== ==============
CAPSTEAD MORTGAGE CORPORATION The weighted average effective interest rate on repurchase arrangements and similar borrowings was 1.79% and 4.18% during 2002 and 2001, respectively. Interest paid on borrowings totaled $50.0 million, $180.7 million and $301.1 million during 2002, 2001 and 2000 respectively. NOTE 8 -- CMO BORROWINGS Each series of CMOs issued consists of various classes of bonds, most of which have fixed rates of interest. Interest is payable monthly or quarterly at specified rates for all classes. Typically, principal payments on each series are made to each class in the order of their stated maturities so that no payment of principal will be made on any class of bonds until all classes having an earlier stated maturity have been paid in full. The components of CMOs along with selected other information were as follows (dollars in thousands):
DECEMBER 31 --------------------------------- 2002 2001 - --------------------------------------------- --------------- --------------- CMOs $ 1,064,164 $ 2,228,091 Accrued interest payable 5,785 12,253 --------------- --------------- Total obligation 1,069,949 2,240,344 Unamortized premium 4,830 4,671 --------------- --------------- $ 1,074,779 $ 2,245,015 =============== =============== Range of average interest rates 1.78% to 9.99% 2.29% to 9.45% Range of stated maturities 2008 to 2030 2008 to 2030 Number of series 17 19
The maturity of each CMO series is directly affected by the rate of principal prepayments on the related Pledged CMO Collateral. Each series is also subject to redemption, generally at the Company's option, provided that certain requirements specified in the related indenture have been met (referred to as "Clean-up Calls"); therefore, the actual maturity of any series is likely to occur earlier than its stated maturity. The weighted average effective interest rate for all CMOs was 7.02% and 7.27% during 2002 and 2001, respectively. Interest paid on CMOs totaled $117.6 million, $194.5 million and $226.6 million during 2002, 2001 and 2000, respectively. NOTE 9 -- BORROWINGS SECURED BY REAL ESTATE The components of borrowings secured by real estate and related weighted average interest rates (calculated including bond issue cost amortization) as of December 31, 2002, were as follows (dollars in thousands):
DECEMBER 31, 2002 -------------------------- BORROWINGS AVERAGE OUTSTANDING RATE ----------- ----------- Mortgage borrowings $ 19,559 7.92% Tax-exempt bonds 100,841 2.74 ----------- $ 120,400 3.58 ===========
CAPSTEAD MORTGAGE CORPORATION Mortgage borrowings consist of a fixed-rate mortgage secured by a senior living facility maturing in 2009. The tax-exempt bonds are secured by mortgages on the remaining five senior living facilities. On November 19, 2002, Capstead refunded the existing tax-exempt bonds with the issuance of $100.8 million of new variable-rate tax-exempt bonds credit-enhanced by Fannie Mae. Interest rates on the new bonds adjust weekly based on the Bond Market Association Municipal Swap Index ("BMA Index"). Interest rate cap agreements with notional amounts aggregating $100.8 million, five-year terms and cap rates equal to a 6% BMA Index were obtained to provide funds to pay interest on the bonds in excess of a 6% BMA Index, should that occur. Monthly principal reserve fund payments are made to the trustee for the eventual retirement of the bonds by 2032. In connection with the issuance of the new bonds, Capstead placed into escrow with the trustee reserves for repairs and replacements totaling $2.7 million. These funds are expected to be released by the trustee during 2003. Another $6.0 million was held by the trustee at December 31, 2002 that will be returned to the Company upon Capstead posting a $6.0 million letter of credit from a rated financial institution to collateralize certain of the bonds. These funds, along with $91,000 of principal reserve funds, are included in Receivables and other assets as restricted cash. Also included in Receivables and other assets are $3.3 million in bond issue costs. The weighted average effective interest rate for all borrowings secured by real estate (calculated including bond issue cost amortization) was 5.87% for the period from May 1, 2002 (assumption of these borrowings) to December 31, 2002. Interest paid on borrowings secured by real estate totaled $4.8 million during 2002. As of December 31, 2002 future maturities and principal reserve fund requirements for these borrowings are as follows (in thousands): 2003 $ 1,345 2004 1,480 2005 1,627 2006 1,785 2007 1,955 Thereafter 112,117 --------- $ 120,309 =========
NOTE 10 -- DISCLOSURES REGARDING FAIR VALUES OF FINANCIAL INSTRUMENTS The carrying amounts of cash and cash equivalents, receivables, payables and repurchase arrangements and similar borrowings approximate fair value. The fair value of Agency Securities, Non-agency Securities, CMBS, CMO investments and borrowings secured by real estate were estimated using either (i) quoted market prices when available, including quotes made by lenders in connection with designating collateral for repurchase arrangements, or (ii) offer prices for similar assets or market positions. The fair value of Pledged CMO Collateral was based on projected cash flows, after payment on the related CMOs, determined using market discount rates and prepayment assumptions. The fair value of CMOs was based on the same method for determining fair value of Pledged CMO Collateral adjusted for credit enhancements. The maturity of mortgage assets is directly affected by the CAPSTEAD MORTGAGE CORPORATION rate of principal payments on the underlying mortgage loans and, for Pledged CMO Collateral, Clean-up Calls of the remaining CMOs outstanding. Fair value disclosures for financial instruments were as follows (in thousands):
DECEMBER 31, 2002 DECEMBER 31, 2001 --------------------------------- --------------------------------- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE - ---------------------------------------- --------------- --------------- --------------- --------------- ASSETS: Cash and cash equivalents $ 59,003 $ 59,003 $ 117,640 $ 117,640 Restricted cash 14,961 14,961 5,880 5,880 Receivables 33,990 33,990 49,283 49,283 Derivatives 587 587 709 709 Mortgage securities and similar investments 2,431,519 2,431,763 3,455,219 3,455,592 CMO collateral and investments 1,083,421 1,084,190 2,262,305 2,250,433 LIABILITIES: Payables 127,515 127,515 38,614 38,614 Repurchase arrangements and similar borrowings 2,145,656 2,145,656 3,207,068 3,207,068 CMOs 1,074,779 1,079,392 2,245,015 2,241,772 Borrowings secured by real estate 120,400 120,714 -- --
Fair value disclosures for available-for-sale debt securities were as follows (in thousands):
GROSS GROSS GROSS COST UNREALIZED UNREALIZED FAIR BASIS GAINS LOSSES VALUE - ----------------------------------- --------------- --------------- --------------- --------------- AS OF DECEMBER 31, 2002 Agency Securities: Fixed-rate $ 1,505 $ 139 $ -- $ 1,644 ARMs 2,150,897 44,251 6 2,195,142 --------------- --------------- --------------- --------------- 2,152,402 44,390 6 2,196,786 Non-agency Securities 83,262 1,504 -- 84,766 CMBS 107,680 112 30 107,762 CMO collateral and investments 26,943 873 2 27,814 --------------- --------------- --------------- --------------- $ 2,370,287 $ 46,879 $ 38 $ 2,417,128 =============== =============== =============== =============== AS OF DECEMBER 31, 2001 Agency Securities: Fixed-rate $ 2,596 $ 241 $ -- $ 2,837 Medium-term 40,410 1,134 -- 41,544 ARMs 3,114,405 46,680 206 3,160,879 --------------- --------------- --------------- --------------- 3,157,411 48,055 206 3,205,260 Non-agency Securities 72,458 1,426 -- 73,884 CMBS 171,691 285 -- 171,976 CMO collateral and investments 44,644 1,491 38 46,097 --------------- --------------- --------------- --------------- $ 3,446,204 $ 51,257 $ 244 $ 3,497,217 =============== =============== =============== ===============
CAPSTEAD MORTGAGE CORPORATION Held-to-maturity debt securities consist of Pledged CMO Collateral and collateral released from the related CMO indentures pursuant to Clean-up Calls and held as Agency or Non-agency Securities. Fair value disclosures for debt securities held-to-maturity were as follows (in thousands):
GROSS GROSS COST UNREALIZED UNREALIZED FAIR BASIS GAINS LOSSES VALUE - ------------------------------------------------------- -------------- -------------- -------------- -------------- AS OF DECEMBER 31, 2002 Released CMO collateral: Agency Securities $ 2,144 $ 192 $ -- $ 2,336 Non-agency Securities 524 52 -- 576 Pledged CMO Collateral 1,055,607 795 4,639 1,051,763 -------------- -------------- -------------- -------------- $ 1,058,275 $ 1,039 $ 4,639 $ 1,054,675 ============== ============== ============== ============== AS OF DECEMBER 31, 2001 Released CMO Collateral: Agency Securities $ 3,144 $ 285 $ -- $ 3,429 Non-agency Securities 955 88 -- 1,043 Pledged CMO Collateral 2,216,208 1,455 10,084 2,207,579 -------------- -------------- -------------- -------------- $ 2,220,307 $ 1,828 $ 10,084 $ 2,212,051 ============== ============== ============== ==============
Sales of released CMO collateral occasionally occur provided the collateral has paid down to within 15% of its original issuance amounts. Sales of debt securities were as follows (in thousands):
YEAR ENDED DECEMBER 31 ------------------------------------------------ 2002 2001 2000 - ------------------------------------------------------- -------------- -------------- -------------- Sale of debt securities held available-for-sale: Amortized cost $ 42,729 $ 474,441 $ 1,389,947 Gain 1,602 6,210 -- Loss -- -- (70,989) Sale of released CMO collateral held-to-maturity: Amortized cost 32,265 94,157 84,547 Gain 1,222 1,746 816
NOTE 11 -- INCOME TAXES Capstead and its qualified REIT subsidiaries ("Capstead REIT") file a separate federal income tax return that does not include the operations of the Company's non-REIT subsidiaries. Provided all taxable income of Capstead REIT is distributed to stockholders within time limits prescribed by the Code, no income taxes are due on this income. Taxable income, if any, of the non-REIT subsidiaries is fully taxable. The non-REIT subsidiaries paid alternative minimum taxes of $81,000 and $2,000 during 2002 and 2000 respectively. No income taxes were paid during 2001. CAPSTEAD MORTGAGE CORPORATION Effective tax rates differed substantially from statutory federal income tax rates because of the effect of the following items (in thousands):
YEAR ENDED DECEMBER 31 -------------------------------------------- 2002 2001 2000 - ----------------------------------------------------------------- ------------ ------------ ------------ Income taxes computed at the federal statutory rate $ 33,643 $ 37,197 $ (18,020) Capital gain generated by Capstead REIT (1,093) (970) (262) Capital loss generated by Capstead REIT -- 609 25,041 Benefit of REIT status (31,205) (39,163) (6,820) ------------ ------------ ------------ Income taxes computed on income of non-REIT subsidiaries 1,345 (2,327) (61) Change in unrecognized deferred income tax asset (1,785) 2,570 (235) Other 521 (243) 298 ------------ ------------ ------------ $ 81 $ -- $ 2 ============ ============ ============
At December 31, 2002 Capstead REIT had capital loss carryforwards for tax purposes of $328 million, of which $258 million expires after 2003, and $70 million expires after 2005. At December 31, 2002 the non-REIT subsidiaries had net operating loss carryforwards for tax purposes of $6.1 million, which expire after 2019 and capital loss carryforwards of $2.1 million, which expire after 2006. In addition, the non-REIT subsidiaries have sufficient alternative minimum tax credit carryforwards to offset the payment of federal income taxes on $5.2 million of future alternative minimum taxable income, if any, earned by these subsidiaries. Significant components of the non-REIT subsidiaries deferred income tax assets and liabilities were as follows (in thousands):
DECEMBER 31 --------------------------- 2002 2001 - --------------------------------------------- ----------- ----------- Deferred income tax assets: Alternative minimum tax credit $ 1,832 $ 1,751 Capital loss carryforwards 751 1,606 Net operating loss carryforwards 822 994 Other 922 1,259 ----------- ----------- 4,327 5,610 Deferred income tax liabilities (516) (14) ----------- ----------- Net deferred tax assets $ 3,811 $ 5,596 =========== =========== Valuation allowance $ 3,811 $ 5,596 =========== ===========
NOTE 12 -- STOCKHOLDERS' EQUITY AND PREFERRED STOCK SUBJECT TO REPURCHASE As of December 31, 2002, the Company had two series of convertible preferred stock outstanding ranking on parity with each other and ahead of the common shares in the event of liquidation. These shares are currently redeemable at the Company's option. Dividends are payable quarterly for the Series A shares and monthly for the Series B shares. Under the terms of the governing Articles Supplementary, common dividend distributions in excess of available quarterly net income results in adjustments to the conversion ratios of the preferred CAPSTEAD MORTGAGE CORPORATION shares. Capstead's preferred shares are each entitled to cumulative fixed dividends with conversion rates and redemption and liquidation preferences as indicated below:
PER SHARE -------------------------------------------------------------------- PREFERRED ANNUALIZED CONVERSION REDEMPTION LIQUIDATION SERIES DIVIDEND RATE * PRICE PREFERENCE - ------------------ ------------ ------------------- ------------------ --------------- A $1.60 1.4628 $16.40 $16.40 B 1.26 0.5632 12.50 11.38
* Reflects number of common shares to be received for each preferred share converted effective January 1, 2003 for the Series A shares and December 31, 2002 for the Series B shares. During 2002, 54,459 Series A shares and 22,547 Series B shares were converted into 52,741 and 12,556 common shares, respectively. On December 9, 1999 Capstead issued 5,378,000 of Series C preferred shares and 5,378,000 of Series D preferred shares to Fortress that were converted on May 4, 2001 and on December 28, 2000, respectively, into an aggregate of 2,689,000 common shares. In addition, during 2000 Fortress acquired an aggregate of 1,960,359 Capstead common shares through open market purchases and a May 2000 tender offer, bringing its holdings to 4,649,359 common shares. In November 2001, Fortress sold one million of these shares in an underwritten offering. As of December 31, 2002, Fortress remains Capstead's largest stockholder, owning 3,649,359 common shares, or approximately 26% of the Company's outstanding common shares (see NOTE 15). Subsequent to year-end Fortress sold a portion of its holdings but remains Capstead's largest stockholder. Pursuant to a 1999 repurchase program, during 2000 the Company repurchased 188,475 common shares at an average price of $15.53 per share and 826,900 Series B shares at an average price of $9.61 per share. No shares were repurchased during 2002 and 2001 pursuant to this repurchase program. On January 25, 2000 the Company repurchased 2,784,250 common shares at a price of $18.54 per share pursuant to a tender offer. On March 22, 2001 the Company repurchased 275,845 common shares at a price of $26.50 per share pursuant to a tender offer. All of the above per share prices include transaction costs. All repurchased shares have been cancelled. Option exercises by directors resulted in net additions to capital of $419,000 and $37,000 during 2001 and 2000, respectively. Option exercises by officers resulted in net additions to capital of $209,000 and $747,000 during 2002 and 2001, respectively. No options were exercised by directors in 2002 or by officers in 2000. The second, third and fourth quarter 2002 common dividends exceeded available net income primarily because of the decision to distribute amounts representing depreciation on real estate held for lease. In addition, similar to a $14.60 per common share special dividend paid June 29, 2001, the fourth quarter common dividend included a special dividend of $7.19 per common share representing a significant portion of the Company's common stockholders' equity. Amounts paid as regular quarterly common dividends in excess of quarterly net income, as well as the special dividends, were recorded as reductions to Paid-in capital. Capstead's Charter provides that if the Board determines in good faith that the direct or indirect ownership of the common shares has become concentrated to an extent which would cause Capstead to fail to qualify as a REIT, the Company may redeem or repurchase, at fair market value, any number of common and/or preferred shares sufficient to maintain or bring such ownership into conformity with the Code. In addition, the Company may refuse to CAPSTEAD MORTGAGE CORPORATION transfer or issue common and/or preferred shares to any person whose acquisition would result in Capstead being unable to comply with the requirements of the Code. Finally, the Charter provides that the Company may redeem or refuse to transfer any capital shares of Capstead necessary to prevent the imposition of a penalty tax as a result of ownership of such shares by certain disqualified organizations, including governmental bodies and tax-exempt entities that are not subject to tax on unrelated business taxable income. Comprehensive income is net income (loss) plus other comprehensive income (loss) which consists of the change in unrealized gain on debt securities classified as available-for-sale and Derivatives held as cash flow hedges. Accumulated other comprehensive income at December 31, 2002 consisted of unrealized gains on debt securities totaling $46.8 million and amounts associated with cash flow hedging activities totaling $630,000. The following provides information regarding comprehensive income (in thousands):
YEAR ENDED DECEMBER 31 ----------------------------------------------- 2002 2001 2000 - ------------------------------------------------------------ ------------- ------------- ------------- Net income (loss) $ 96,123 $ 106,276 $ (51,486) ------------- ------------- ------------- Other comprehensive income (loss): Unrealized gain on cash flow hedges: Initial gain on adoption of SFAS 133 -- 1,365 -- Change in unrealized gain during period (113) (354) -- Reclassification adjustment for amounts included in net income (loss) (198) (70) -- Unrealized gain (loss) on debt securities: Change in unrealized gain (loss) during period (2,570) 37,778 22,656 Reclassification adjustment for amounts included in net income (loss) (1,602) (6,210) 90,077 ------------- ------------- ------------- Other comprehensive income (loss) (4,483) 32,509 112,733 ------------- ------------- ------------- Comprehensive income $ 91,640 $ 138,785 $ 61,247 ============= ============= =============
NOTE 13 -- EMPLOYEE AND DIRECTOR BENEFIT PLANS The Company sponsors stock plans to provide for the issuance of nonvested stock, stock options and other incentive-based stock awards (collectively, the "Plans"). As of December 31, 2002, the Plans provide for the issuance of up to an aggregate of 2,277,004 common shares of which 1,283,418 remain available for future issuance. Nonvested stock grants for 53,577 common shares were issued to employees other than the chairman on April 20, 2000 (grant date fair value $14.25 per share). These grants are subject to certain restrictions, including continuous employment, which generally lapse over five years. Costs associated with nonvested stock grants (measured by the fair value of the common shares on the date of grant multiplied by the number of shares granted) are recognized as compensation expense over the vesting period. Stock options granted and currently outstanding have terms and vesting requirements at the grant date of up to ten years and generally have been issued with strike prices equal to the quoted market prices of the Company's stock on the date of grant. Certain outstanding stock options previously granted to directors provide for the annual granting of dividend equivalent rights ("DERs") that permit the optionholder to obtain additional common shares at no cost based upon formulas set forth in the Plans. The information in the following CAPSTEAD MORTGAGE CORPORATION tables regarding option grants outstanding and stock option activity reflects activity through January 21, 2003, the date all existing stock grants were canceled and replaced with new option grants (see the note to the second table):
OPTION GRANTS OUTSTANDING AS OF JANUARY 21, 2003 - ---------------------------------------------------------------------------------------------------------------- RANGE OF -------------------------------------- OPTIONS OPTIONS EXERCISE REMAINING ORIGINAL GRANT DATE * OUTSTANDING EXERCISABLE PRICES ** LIFE (YEARS) ** - --------------------------------------- --------------- ---------------- -------------------- ------------------ After December 31, 1998 137,022 66,980 $3.93 to $13.39 7 to 9 Prior to December 31, 1998 336,029 336,029 $7.00 to $35.37 1 to 5 ------------ ----------- 473,051 403,009 ============ ===========
* Includes related DER grants made to directors. ** Weighted average exercise prices (adjusted for related DER grants) and weighted average lives of these significant option grants were $7.66 and eight years, and $27.05 and four years, respectively.
STOCK OPTION ACTIVITY FROM JANUARY 1, 2000 TO JANUARY 21, 2003 - --------------------------------------------------------------------------------------------------------- NUMBER OF WEIGHTED AVERAGE SHARES EXERCISE PRICE - ----------------------------------------------------------------- ------------------- ------------------- As of January 1, 2000 (374,386 exercisable) 374,386 $71.42 DER grants (average fair value: $16.75 per share) 1,307 - Ordinary grants (average fair value: $1.73 per share) 116,671 14.29 Exercises (2,295) 16.30 Cancellations (248,518) 70.80 --------------- As of December 31, 2000 (162,486 exercisable) 241,551 44.62 Ordinary grants (average fair value: $1.87 per share) 34,063 21.05 Exercises (76,337) 15.33 Cancellations * (189,941) 52.94 Grants in connection with recapitalization * 321,971 31.23 --------------- As of December 31, 2001 (241,958 exercisable) 331,307 31.46 DER grants (average fair value $16.36 per share) 3,072 - Ordinary grants (average fair value: $2.55 per share) 11,765 20.70 Exercises (44,676) 8.41 Cancellations (1,110) 11.02 --------------- As of December 31, 2002 (255,685 exercisable) 300,358 33.89 DER grants (average fair value $19.75 per share) 2,870 - Cancellations * (303,228) 33.57 Grants in connection with recapitalization * 473,051 21.43 --------------- As of January 21, 2003 (403,009 exercisable) 473,051 21.43 ===============
* In June 2001 and in January 2003 significant capital was returned to the common stockholders via special dividend payments resulting in recapitalizations of the Company. Accordingly, all existing options were canceled and replaced with new option grants for an increased number of shares at a reduced exercise price that retained the same vesting and expiration characteristics as the canceled grants such that each optionholder's economic position remained unchanged subsequent to the recapitalizations. The new grants are accounted for as non-compensatory. Compensation costs for stock awards granted by the Company pursuant to APB25 totaled $140,000, $136,000 and $108,000 in 2002, 2001 and 2000, respectively. The effect described in NOTE 2 of determining compensation cost for stock options granted since the beginning of 1995 based upon the estimated fair value at the grant date consistent with the methodology prescribed under SFAS 123 was determined using a Black-Scholes option pricing model and, depending upon each individual option grant during the last three years, CAPSTEAD MORTGAGE CORPORATION dividend yields of 12% to 15%, volatility factors of 35% to 51%, expected life assumptions of two to four years and risk-free rates of between 3.1% and 6.3%. The Company also sponsors a qualified defined contribution retirement plan for all employees. The Company matches up to 50% of a participant's voluntary contribution up to a maximum of 6% of a participant's compensation and may make additional contributions of up to another 3% of a participant's compensation. All Company contributions are subject to certain vesting requirements. Contribution expenses were $96,000, $47,000 and $161,000 in 2002, 2001 and 2000, respectively. NOTE 14 -- COMMITMENTS AND CONTINGENCIES During 1998, twenty-four purported class action lawsuits were filed against the Company and certain of its officers alleging, among other things, that the defendants violated federal securities laws by publicly issuing false and misleading statements and omitting disclosure of material adverse information regarding the Company's business. In March 1999, these actions were consolidated and in July 2000, the court appointed a lead plaintiff group. An amended complaint was filed in October 2000. The amended complaint claims that as a result of alleged improper actions, the market prices of the Company's equity securities were artificially inflated during the period between April 17, 1997 and June 26, 1998. The amended complaint seeks monetary damages in an undetermined amount. In February 2001 the Company responded to this amended complaint with a motion to dismiss all allegations against the Company and the named officers. In April 2001 the plaintiffs responded to the Company's motion to dismiss and the Company filed its reply to the plaintiffs' response in May 2001. On February 6, 2003 the court entered an order stating that it will issue a decision on the motion to dismiss no later than March 7, 2003. The Company believes it has meritorious defenses to the claims and intends to vigorously defend the actions. Based on available information, management believes the resolution of these suits will not have a material adverse effect on the financial position of the Company. NOTE 15 -- TRANSACTIONS WITH AFFILIATES Fortress is Capstead's largest stockholder. Through a management contract, Fortress provides the services of Mr. Edens as Capstead's chairman and chief executive and of other individuals as necessary to perform support services for Mr. Edens. This contract renews annually on December 31 unless terminated by Fortress or by majority vote of the Board of Directors that are independent of Fortress. Under the terms of the contract, Fortress is entitled to a $375,000 base annual fee and a cash management incentive fee (see NOTE 2). In addition, Fortress may be awarded long-term, non-cash incentive compensation, which may be in the form of stock options or grants. Included in Other operating expense is $375,000, $375,000 and $260,000 of base fees paid to Fortress for services rendered during 2002, 2001 and 2000, respectively. Included in Management and affiliate incentive fee is $4,982,000, $8,133,000 and $130,000 of cash management incentive fees awarded to Fortress for these periods, respectively. No long-term, non-cash compensation has been awarded. See NOTE 6 for information regarding Fortress' involvement through its affiliate Brookdale in the acquisition and long-term leasing of senior living facilities acquired by Capstead in 2002. Under a separate arrangement, which terminated in early 2001, the Company provided accounting and cash management services to Fortress for one of its affiliates. Included in CAPSTEAD MORTGAGE CORPORATION Other revenue is $33,000 and $160,000 Capstead received pursuant to this arrangement for services rendered in 2001 and 2000, respectively. NOTE 16 -- NET INTEREST INCOME ANALYSIS (UNAUDITED) The following summarizes interest income and interest expense and weighted average interest rates (dollars in thousands):
2002 2001 2000 ----------------------- ----------------------- ---------------------- AVERAGE AVERAGE AVERAGE EFFECTIVE EFFECTIVE EFFECTIVE AMOUNT RATE AMOUNT RATE AMOUNT RATE - ------------------------------------------ ----------- ---------- ---------- ------------ ----------- ---------- Interest income: Mortgage securities and similar investments $150,302 5.17% $274,480 6.52% $349,533 6.68% CMO collateral and investments 114,353 6.88 198,216 7.24 237,052 7.28 --------- --------- --------- Total interest income 264,655 472,696 586,585 --------- --------- --------- Interest expense: Repurchase arrangements and similar borrowings 48,329 1.79 164,422 4.18 303,126 6.31 CMOs 116,069 7.02 197,905 7.27 237,479 7.35 --------- --------- --------- Total interest expense 164,398 362,327 540,605 --------- --------- --------- $100,257 $110,369 $ 45,980 ======== ======== =========
Changes in interest income and interest expense due to changes in interest rates versus changes in volume were as follows (in thousands):
RATE* VOLUME* TOTAL* - -------------------------------------------------------- -------------- ---------------- ----------- 2002/2001 Interest income: Mortgage securities and similar investments $(49,502) $ (74,676) $(124,178) CMO collateral and investments (9,420) (74,443) (83,863) --------- --------- ---------- Total interest income (58,922) (149,119) (208,041) --------- --------- ---------- Interest expense: Repurchase arrangements and similar borrowings (74,817) (41,276) (116,093) CMOs (6,414) (75,422) (81,836) --------- --------- ---------- Total interest expense (81,231) (116,698) (197,929) --------- --------- ---------- $ 22,309 $ (32,421) $ (10,112) ========= ========= ========== 2001/2000 Interest income: Mortgage securities and similar investments $ (7,746) $ (67,307) $ (75,053) CMO collateral and investments (1,167) (37,669) (38,836) --------- --------- ---------- Total interest income (8,913) (104,976) (113,889) --------- --------- ---------- Interest expense: Repurchase arrangements and similar borrowings (89,930) (48,774) (138,704) CMOs (2,528) (37,046) (39,574) --------- --------- ---------- Total interest expense (92,458) (85,820) (178,278) --------- --------- ---------- $ 83,545 $ (19,156) $ 64,389 ========= ========= ==========
* The change in interest income and interest expense due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. CAPSTEAD MORTGAGE CORPORATION NOTE 17 -- QUARTERLY RESULTS (UNAUDITED) Summarized quarterly results of operations were as follows (in thousands, except per share amounts).
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER - ------------------------------------------------------------- ------------- ------------- -------------- ----------- YEAR ENDED DECEMBER 31, 2002 Interest income $83,202 $70,763 $61,182 $49,508 Interest and related expenses 52,201 44,099 38,624 30,070 ------- ------- ------- ------- Net margin on financial assets 31,001 26,664 22,558 19,438 Net margin on real estate held for lease - 249 339 289 Other revenue (expense) (2,626) (2,327) (146) 684 ------- ------- ------- ------- $28,375 $24,586 $22,751 $20,411 ======= ======= ======= ======= Net income per common share: Basic $1.68 $1.41 $1.27 $1.11 Diluted 1.43 1.24 1.15 1.03
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER - ------------------------------------------------------------- ------------- ------------- -------------- ----------- YEAR ENDED DECEMBER 31, 2001 Interest income $143,327 $126,465 $108,193 $94,711 Interest and related expenses 121,105 98,287 81,414 62,511 --------- -------- --------- ------- Net margin on financial assets 22,222 28,178 26,779 32,200 Other revenue (expense) 2,427 (409) (1,703) (3,418) --------- -------- --------- ------- $ 24,649 $ 27,769 $ 25,076 $28,782 ========= ======== ========= ======= Net income per common share: Basic $1.49 $1.77 $1.45 $1.71 Diluted 1.39 1.63 1.27 1.45
NOTE 18 -- MARKET AND DIVIDEND INFORMATION (UNAUDITED) The New York Stock Exchange trading symbol for Capstead's common shares is CMO. There were 2,647 common stockholders of record at December 31, 2002. In addition, depository companies held common shares for 23,626 beneficial owners. The high and low sales prices and dividends declared on the common shares were as follows:
YEAR ENDED DECEMBER 31, 2002 YEAR ENDED DECEMBER 31, 2001 ------------------------------------------- ------------------------------------------- SALES PRICES SALES PRICES --------------------------- DIVIDENDS --------------------------- DIVIDENDS HIGH LOW DECLARED HIGH LOW DECLARED - -------------- ----------- ----------- ----------- ----------- ----------- ----------- First quarter $ 23.35 14.23 $ 1.65 $ 26.90 $ 21.50 $ 0.98 Second quarter 23.14 17.75 1.43 36.40 26.20 1.56 Third quarter 23.00 19.01 1.32 28.49 19.01 1.50 Fourth quarter 24.99 18.42 1.16 29.50 23.50 1.50 Special * 7.19 14.60
* On June 29, 2001 Capstead paid a special dividend of $14.60 per common share. On December 12, 2002 Capstead declared a special dividend of $7.19 per common share together with a regular quarterly dividend of $1.16 per common share that was paid January 21, 2003 (see NOTE 12). CAPSTEAD MORTGAGE CORPORATION SELECTED FINANCIAL DATA (In thousands, except per share amounts)
YEAR ENDED DECEMBER 31 -------------------------------------------------------------------------------- 2002 2001 2000 1999 1998 - ----------------------------------------------- -------------- -------------- -------------- -------------- -------------- SELECTED CONSOLIDATED STATEMENT OF OPERATIONS DATA: Interest income $ 264,655 $ 472,696 $ 586,585 $ 563,159 $ 667,198 Interest and related expense 164,994 363,317 542,150 504,947 659,575 -------------- -------------- -------------- -------------- -------------- Net margin on financial assets 99,661 109,379 44,435 58,212 7,623 Net margin on real estate held for lease (a) 877 -- -- -- -- Other revenue (expense) (b) (4,415) (3,103) (95,921) (303) (242,387) -------------- -------------- -------------- -------------- -------------- Net income (loss) $ 96,123 $ 106,276 $ (51,486) $ 57,909 $ (234,764) ============== ============== ============== ============== ============== Net income (loss) per common share: (c) Basic $ 5.47 $ 6.43 $ (6.59) $ 2.42 $ (16.87) Diluted 4.85 5.68 (6.59) 2.42 (16.87) Cash dividends paid per share: (c) Common - regular 5.56 5.54 1.42 2.40 4.00 Common - special (d) 7.19 14.60 -- -- -- $1.60 Series A Preferred 1.60 1.60 1.60 1.60 1.60 $1.26 Series B Preferred 1.26 1.26 1.26 1.26 1.26 $0.56 Series C Preferred (e) -- -- 0.56 0.03 -- $0.40 Series D Preferred (e) -- -- 0.30 0.02 -- Average number of common shares outstanding: (c) Basic 13,858 13,351 11,487 14,587 15,237 Diluted 19,827 16,956 11,487 14,762 15,237 SELECTED CONSOLIDATED BALANCE SHEET DATA: Mortgage securities and similar investments $ 2,431,519 $ 3,455,219 $ 5,394,459 $ 5,408,714 $ 2,369,602 CMO collateral and investments 1,083,421 2,262,305 3,126,878 3,318,886 4,571,274 Real estate held for lease (a) 137,122 -- -- -- -- Total assets 3,766,928 5,895,425 8,610,497 8,807,039 7,100,287 Repurchase arrangements and similar borrowings 2,145,656 3,207,068 4,904,632 4,872,392 1,839,868 Borrowings secured by real estate (a) 120,400 -- -- -- -- Collateralized mortgage obligations 1,074,779 2,245,015 3,103,874 3,289,584 4,521,324 Preferred stock subject to repurchase (e) -- -- 25,210 50,584 -- Stockholders' equity 298,578 404,728 545,669 563,806 680,201
NOTE: See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to Consolidated Financial Statements" for discussion of changes to the Company's operations that are expected to impact future operating results. (a) In May 2002, Capstead made its first direct investment in real estate, a portfolio of senior living facilities leased to an affiliate. (b) Results in 2000 include losses on the sale of financial assets incurred with the modification of the Company's investment strategy to focus on adjustable-rate financial assets. Results in 1998 include losses from the sale of financial assets, principally interest-only mortgage securities and the results of the Company's servicing operations which were sold in 1998. (c) Amounts have been adjusted for two 1-for-2 reverse common stock splits effective July 2, 2001 and May 8, 2000, respectively. (d) The 2002 special dividend was a component of the $8.35 fourth quarter common dividend declared December 12, 2002 and paid January 21, 2003. The 2001 $14.60 special common dividend was paid June 29, 2001. Both special dividends were recorded as reductions to Paid-in Capital. (e) The Series C and D preferred shares were converted into common shares on May 4, 2001 and December 28, 2000, respectively. CAPSTEAD MORTGAGE CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION OVERVIEW Capstead Mortgage Corporation ("Capstead" or the "Company") operates as a real estate investment trust ("REIT") earning income from investing in real estate-related assets on a leveraged basis and from other investment strategies. These investments currently include, but are not limited to, single-family residential adjustable-rate mortgage ("ARM") securities issued by government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities"). The Company has also made limited investments in credit-sensitive commercial real estate-related assets, including the direct ownership of real estate, intended to produce attractive returns due largely to a higher risk of default and reduced liquidity compared to Agency Securities. As existing investments prepay or mature, Capstead has the opportunity to reinvest a portion of its equity capital into investments that can produce attractive returns over the long term, with less sensitivity to changes in interest rates than Agency Securities. To this end, the Company continues to evaluate suitable real estate-related investments, which may include more credit-sensitive assets. However, during the last two years the Company has returned a significant portion of its equity capital to its common stockholders, primarily because of a lack of suitable investment opportunities. There can be no assurance that suitable investments at attractive pricing will be available on a timely basis to replace portfolio runoff as it occurs (see "Reductions in Common Equity Capital," "Effects of Interest Rate Changes," "Risks Associated with Credit-Sensitive Investments" and "Risks Associated with Owning Real Estate"). REDUCTIONS IN COMMON EQUITY CAPITAL In December 2002 Capstead declared a $7.19 per common share special dividend (included as part of the $8.35 fourth quarter 2002 common dividend paid in January 2003) resulting in the return of $100.4 million of its equity capital to its common stockholders. This follows a June 2001 special dividend distribution of $14.60 per common share. These special dividends have significantly reduced common equity capital relative to total equity capital. As seen with the 2001 special dividend, the 2002 special dividend should serve to enhance future returns on remaining common equity, particularly under current market conditions, while maintaining adequate liquidity to take advantage of investment opportunities as they arise. Of course, while the resulting capital structure can produce higher percentage returns on common equity under favorable conditions than before the capital reductions, declines in earnings or book value can also have a more pronounced negative impact on these returns. As of December 31, 2002, the Company's book value per common share was $8.23, a decline of $7.64 from the prior year (calculated using the stated liquidation preferences for the Series A and B preferred shares). Book value declined primarily because of the $7.19 special dividend, dividend payments in excess of quarterly net income and a reduction in the CAPSTEAD MORTGAGE CORPORATION aggregate unrealized gain on the Company's investments (most of which are debt securities carried at fair value with changes in fair value reflected in stockholders' equity) as a result of runoff caused by mortgage prepayments. This unrealized gain can be expected to continue to decline with runoff and to fluctuate with changes in interest rates and market liquidity, and such changes will largely be reflected in book value per common share. Book value will also be affected by other factors, including the level of dividend distributions and depreciation charges on net-leased real estate; however, temporary changes in fair values of investments not held in the form of debt or equity securities generally will not affect book value. MORTGAGE SECURITIES AND SIMILAR INVESTMENTS As of December 31, 2002, mortgage securities and similar investments consisted primarily of ARM Agency Securities (see "NOTE 4" to the accompanying consolidated financial statements for discussion of how the Company classifies its mortgage securities and similar investments). Agency Securities are AAA-rated and are considered to have limited credit risk. Non-agency securities are private mortgage pass-through securities whereby the related credit risk of the underlying loans is borne by AAA-rated private mortgage insurers ("Non-agency Securities"). In connection with the formation of private mortgage pass-through securities prior to 1995, the Company was required to establish reserve funds available to pay special hazard (e.g. earthquake or mudslide-related losses) or certain bankruptcy costs. The private mortgage pass-through securities were subsequently held as Non-agency Securities, CMO collateral or sold to third parties. Included in Receivables and other assets as restricted cash are $4.9 million in special hazard reserve funds and $1.2 million of bankruptcy reserve funds associated with $75 million and $79 million of loans outstanding as of December 31, 2002, respectively. Commercial mortgage-backed securitizations generally have senior, mezzanine and subordinate classes of bonds with the lower classes providing credit enhancement to the more senior classes. Commercial mortgage-backed securities ("CMBS") held by the Company at December 31, 2002 are mezzanine classes and therefore carry credit risk associated with the underlying pools of commercial mortgage loans that is mitigated by subordinate bonds held by other investors. Commercial loans held by the Company at December 31, 2002 consist of a loan to a joint venture that holds commercial real estate (see "Risks Associated With Credit-Sensitive Investments"). Mortgage securities are financed under repurchase arrangements with investment banking firms pursuant to which the portfolios are pledged as collateral. Capstead financed its commercial loan investment with a loan from a commercial bank. Should the Company acquire additional financial assets that are not mortgage-backed securities, similar financing arrangements with other parties, such as commercial banks, may be employed (see "Liquidity and Capital Resources"). The Company's portfolio of mortgage securities and similar investments declined during the twelve months ended December 31, 2002 to $2.4 billion from $3.5 billion at December 31, 2001, primarily as a result of portfolio runoff caused by mortgage prepayments. Acquisitions during 2002 were limited to $99 million of CMBS and commercial loans and $85 million of mortgage securities released from "sold CMO" indentures, $43 million of which were sold (see "CMO Collateral and Investments"). To the CAPSTEAD MORTGAGE CORPORATION extent the proceeds of mortgage prepayments and other maturities are not reinvested or cannot be reinvested at a rate of return on invested capital at least equal to the return earned on previous investments, earnings may decline. The future size and composition of the Company's investment portfolios will depend on market conditions, including levels of mortgage prepayments and the availability of suitable investments at attractive pricing (see "Effects of Interest Rate Changes"). The following yield and cost analysis illustrates results achieved during 2002 for components of the mortgage securities and similar investments portfolio and anticipated first quarter 2003 asset yields and borrowing rates based on interest rates in effect on February 6, 2003 (the date fourth quarter 2002 results were released and based on interest rates in effect at that date) (dollars in thousands):
2002 AVERAGE (a) AS OF DECEMBER 31, 2002 ------------------------------------------ ---------------------------- PROJECTED LIFETIME ACTUAL ACTUAL PREMIUMS 1ST QUARTER PREPAYMENT BASIS YIELD/COST RUNOFF (DISCOUNTS) BASIS (a) YIELD/COST (b) ASSUMPTIONS ------------- ------------- ------------- ------------- ------------- ------------- ------------- Agency Securities: Fannie Mae/Freddie Mac: Fixed-rate $ 4,512 9.48% 35% $ 21 $ 3,649 9.41% 25% Medium-term 24,336 6.19 42 -- -- -- -- ARMs: LIBOR/CMT 1,326,773 5.04 29 16,376 1,136,518 4.02 40 COFI 141,358 5.30 24 (3,655) 122,701 4.87 20 Ginnie Mae ARMs 1,119,804 5.25 36 9,767 891,678 4.57 26 ------------- ------------- ------------- 2,616,783 5.16 32 22,509 2,154,546 4.30 33 Non-agency Securities 91,384 5.62 28 713 83,786 4.67 35 CMBS and other commercial loans 192,019 4.97 34 (277) 147,217 4.75 -- ------------- ------------- ------------- 2,900,186 5.17 33 $ 22,945 2,385,549 4.34 31 ============= Borrowings 2,656,776 1.79 2,145,656 1.38 ------------- ------------- Capital employed/ financing spread $ 243,410 3.38 $ 239,893 2.96 ============= ============= Return on assets (c) 3.50 3.08
(a) Basis represents the Company's investment before unrealized gains and losses. Actual asset yields, runoff rates, borrowing rates and resulting financing spread are presented on an annualized basis. (b) Projected annualized yields for the first quarter of 2003 reflect ARM coupon resets and lifetime prepayment assumptions as adjusted for expected annualized prepayments for this quarter only, as of February 6, 2003. Actual yields realized in future periods will largely depend upon (i) changes in portfolio composition, (ii) ARM coupon resets, (iii) actual prepayments and (iv) any changes in lifetime prepayment assumptions. (c) The Company uses its liquidity to pay down borrowings. Return on assets is calculated on an annualized basis assuming the use of this liquidity to reduce borrowing costs (see "Utilization of Capital and Potential Liquidity"). Although the overall yield earned on the Company's mortgage securities and similar investments portfolio averaged 5.17% during 2002, by the fourth quarter of 2002 yields had fallen to 4.65%. After having peaked at 7.06% during the first quarter of 2001, portfolio yields have declined steadily over the past two years, reflecting the trend of declining interest rates that has been evident since the Federal Reserve began lowering short-term CAPSTEAD MORTGAGE CORPORATION interest rates in January 2001. Yields on ARM securities fluctuate as coupon interest rates on the underlying mortgage loans reset periodically based on underlying indices generally subject to limits on the amount of change during any single interest rate adjustment period. As such, ARM yields are expected to continue to decline in 2003. For example, if interest rates stabilize at rates in effect February 6, 2003, average quarterly yields on the portfolio could decline a total of 91 basis points by the fourth quarter of 2003 from yields achieved the fourth quarter of 2002. Actual yields will depend on fluctuations in, and market expectations for fluctuations in, interest rates and levels of mortgage prepayments (see "Effects of Interest Rate Changes"). Although still at elevated levels, mortgage prepayment rates moderated somewhat during 2002 as interest rates on most of the mortgage loans underlying the Company's ARM securities have reset to levels at or below current interest rates on fixed-rate mortgage loans, reducing or eliminating the advantage for these homeowners to refinance. Prepayments should continue to moderate as loans continue to reset lower. Annualized prepayment rates on Ginnie Mae ARM securities averaged 36% during 2002, compared to a 37% annualized rate during 2001. Annualized prepayment rates on Fannie Mae and Freddie Mac ARM securities averaged 29% during 2002 compared to 33% during 2001. While lower prepayment levels improve mortgage investment yields by allowing related purchase premiums to be recognized in operating results over a longer period, higher prepayment levels shorten the period over which premiums are amortized thus reducing investment yields. More importantly, high prepayment levels can lead to lower portfolio balances as discussed above (see "Effects of Interest Rate Changes"). Having benefited from reductions in the Federal Funds Rate totaling 475 basis points during 2001, short-term interest rates were relatively stable during the first three quarters of 2002. With the action taken by the Federal Reserve in November 2002 to reduce the Federal Funds Rate by an additional 50 basis points, the Company's average borrowing rates declined by 22 basis points during the fourth quarter to 1.62% and are expected to decline an additional 24 basis points during the first quarter of 2003. This decline is not expected to fully offset the effects on earnings of declining portfolio yields and balances. The Company's borrowing rates depend on actions by the Federal Reserve to change short-term interest rates, market expectations of future changes in short-term interest rates and the extent of changes in financial market liquidity (see "Effects of Interest Rate Changes"). CMO COLLATERAL AND INVESTMENTS Since exiting the residential mortgage loan conduit business in 1995, Capstead has maintained finance subsidiaries with capacity to issue collateralized mortgage obligations ("CMOs") and other securitizations backed by single-family residential mortgage loans. From time to time, the Company may purchase mortgage loans from originators or conduits, place these loans into private mortgage pass-through securities and issue CMOs or other securities backed by these securities. The Company may or may not retain a significant residual economic interest in these securitizations. Most of the Company's securitizations have been afforded financing accounting treatment with the related collateral recorded as pledged CMO collateral and the outstanding bonds recorded as CMO liabilities (referred to as "financed CMOs"). Other securitizations issued by the Company in 1993 and prior were treated as sales transactions (referred to as "sold CMOs"). During the past two years, the Company has not issued any CMOs. From time to time, the Company exercises its rights to CAPSTEAD MORTGAGE CORPORATION redeem previously issued CMOs (referred to as "clean-up calls") and either sell or hold the released collateral for investment. During 2002, the Company exercised clean-up calls related to two financed and six sold CMOs selling $77 million of fixed-rate securities and retaining for investment $41 million of ARM securities released from the related indentures. During 2003 the Company expects to exercise clean-up calls redeeming additional CMOs. Credit risk associated with pledged CMO collateral is borne by AAA-rated private mortgage insurers or by subordinated bonds usually sold to investors. The Company has retained $33,000 of credit risk held in the form of subordinated bonds associated with $76 million of pledged CMO collateral outstanding as of December 31, 2002. In addition, Capstead retained a $1.8 million subordinated bond in connection with a sold CMO that is available to pay special hazard costs or certain bankruptcy costs associated with $33 million of loans outstanding as of December 31, 2002. Other than clean-up calls, the Company does not hold any other interests in sold CMOs. CMO collateral and investments, net of related bonds, was $8.6 million at December 31, 2002, down from $17.3 million at year-end 2001. Included in this net investment are $3.7 million of remaining CMO collateral premiums (net of CMO bond premiums). Similar to premiums on other financial assets, CMO collateral and bond premiums are amortized to income as CMO collateral yield or bond expense adjustments based on both actual prepayments and lifetime prepayment assumptions (see "Effects of Interest Rate Changes"). REAL ESTATE HELD FOR LEASE On May 1, 2002 Capstead closed on its first direct investment in real estate, a portfolio of seven senior living properties in five states (the "Properties"). Six of the seven Properties are primarily independent senior living facilities wherein the operator of the facility provides the tenants little, if any, medical care. The smallest property in the portfolio, a skilled nursing facility, was sold in October 2002. No gain or loss was recognized on this transaction. The acquisition of the Properties is in keeping with the Company's strategy of making suitable real estate-related investments intended to produce attractive returns over the long term, with less sensitivity to changes in interest rates than most investments in residential mortgage-backed securities. The following table summarizes the properties acquired:
YEAR PROPERTY LOCATION UNITS (a) CCUPANCY (b) OPENED - ---------------------------- ------------------ ------------------------ ------------- -------- Chambrel at Roswell Roswell, GA 280 (256 IL; 24 AL) 93.6% 1987 Chambrel at Pinecastle Ocala, FL 161 (120 IL; 41 AL) 95.7 1987 Chambrel at Island Lake Longwood, FL 269 (229 IL; 40 AL) 98.5 1985 Chambrel at Montrose Akron, OH 168 (136 IL; 32 AL) 95.8 1987 Chambrel at Williamsburg Williamsburg, VA 255 (200 IL; 55 AL) 98.4 1987 Chambrel at Club Hill Garland, TX 260 (192 IL; 68 AL) 91.2 1987 ----------------------- Total 1,393 (1,133 IL; 260 AL) 95.5 =======================
(a) IL refers to Independent Living units and AL refers to Assisted Living units. (b) As of December 31, 2002. CAPSTEAD MORTGAGE CORPORATION The aggregate purchase price of the Properties (after adjustment for the subsequent sale of the skilled nursing facility) was $139.7 million including the assumption by Capstead of $19.7 million of related mortgage debt and $101.1 million of tax-exempt bond debt. The Properties were acquired pursuant to a purchase contract negotiated by a subsidiary of Brookdale Living Communities, Inc. (collectively with its subsidiaries, "Brookdale"), and assigned to Capstead. Brookdale, an owner, operator, developer and manager of senior living facilities, is a majority-owned affiliate of Fortress Investment Group, LLC (together with its affiliates, "Fortress"). Fortress is Capstead's largest stockholder. Concurrent with the acquisition of the Properties, the Company entered into a long-term "net-lease" arrangement with Brookdale (the "Lease") under which Brookdale is responsible for the ongoing operation and management of the Properties. The Lease has an initial term of 20 years and provides for two 10-year renewal periods. Beginning at the end of five years, Brookdale will have the option of purchasing all of the Properties from Capstead at the greater of fair value or Capstead's original cost, after certain adjustments. Under the terms of the Lease, Brookdale is responsible for paying all expenses associated with operating the Properties, including real estate taxes, other government charges, insurance, utilities and maintenance, and an amount representing an attractive cash return on Capstead's equity in the Properties after payment of monthly debt service. After an initial three-month rent concession period, the cash return on Capstead's equity is expected to exceed 15% on an annualized basis and is subject to annual increases based upon increases (capped at 3%) in the Consumer Price Index. In keeping with Capstead's strategy of reinvesting a portion of its capital into investments that can produce attractive returns over the long term with less sensitivity to changes in interest rates, any future changes in monthly debt service requirements are the responsibility of Brookdale under the terms of the Lease (see "Risks Associated with Owning Real Estate"). UTILIZATION OF CAPITAL AND POTENTIAL LIQUIDITY The Company's utilization of capital and potential liquidity as of December 31, 2002 were as follows (in thousands):
POTENTIAL CAPITAL LIQUIDITY ASSETS BORROWINGS EMPLOYED (a) -------------- -------------- -------------- -------------- Mortgage securities and similar investments: Agency Securities $ 2,198,930 $ 1,980,050 $ 218,880 $ 156,940 Non-agency Securities 85,290 37,677 47,613 43,398 CMBS and other commercial loans 147,299 127,929 19,370 277 -------------- -------------- -------------- -------------- 2,431,519 2,145,656 285,863 200,615 CMO collateral and investments 1,083,421 1,074,779 8,642 -- Real estate held for lease 137,122 120,400 16,722 -- -------------- -------------- -------------- -------------- $ 3,652,062 $ 3,340,835 311,227 200,615 ============== ============== Other assets, net of other liabilities 103,936 59,003 (b) Fourth quarter common dividend (116,585) (116,585) (c) -------------- -------------- $ 298,578 $ 143,033 ============== ==============
(a) Based on maximum borrowings available under existing uncommitted repurchase arrangements considering the fair value of related collateral as of December 31, 2002 (see "Liquidity and Capital Resources). (b) Represents cash and cash equivalents. (c) The fourth quarter common dividend was declared December 12, 2002 and paid January 21, 2003. CAPSTEAD MORTGAGE CORPORATION The Company generally finances its mortgage securities and similar investments with investment banking firms with repurchase arrangements and similar borrowings (see "Liquidity and Capital Resources"). CMO collateral is pledged to secure CMO bonds. Real estate held for lease is financed by long-term borrowings. Liquidity is affected by, among other things, changes in market value of assets pledged under borrowing arrangements, principal prepayments and general conditions in the investment banking, mortgage finance and real estate industries. Future levels of financial leverage will be dependent upon many factors, including the size and composition of the Company's investment portfolios (see "Liquidity and Capital Resources" and "Effects of Interest Rate Changes"). TAX CONSIDERATIONS OF COMMON DIVIDENDS Each common dividend distribution applicable to the 2002 tax year consists of 41.25% ordinary taxable income and 58.75% return of capital. This has been determined based on the ratio of Capstead's 2002 taxable income to total 2002 distributions applied to each 2002 common dividend distribution, including the $8.35 fourth quarter dividend declared in December 2002 and paid in January 2003. Stockholders receiving all $12.75 of 2002 common dividends received taxable income of $5.26 per share and return of capital distributions of $7.49 per share. Stockholders should reduce the tax cost basis of their shares by the amount of return of capital distributions received. Return of capital distributions received in excess of tax cost basis should be reported as capital gain. Due to the complex nature of the applicable tax rules, it is recommended that stockholders consult their tax advisors to ensure proper tax treatment of common dividends received. The following table provides the tax characteristics of Capstead's common dividend distributions for the last three years:
COMMON RETURN DIVIDEND CAPITAL ORDINARY OF TAX YEAR DISTRIBUTIONS GAIN * INCOME * CAPITAL * - ---------------- --------------- ------------- ----------- ----------- 2002 $12.75 --% 41.25% 58.75% 2001 20.14 -- 28.90 71.10 2000 1.42 -- 70.42 29.58
* The indicated characterization percentage is applicable to each quarterly or special common dividend received with respect to a given tax year (additional dividend characterization information is available at www.capstead.com). CAPSTEAD MORTGAGE CORPORATION RESULTS OF OPERATIONS Comparative net operating results (interest income or fee revenue, net of related interest expense and, in the case of real estate held for lease and CMO administration, related direct and indirect operating expense) by source were as follows (in thousands, except per share amounts):
YEAR ENDED DECEMBER 31 ------------------------------------------------------ 2002 2001 2000 - ------------------------------------------------------- -------------- -------------- -------------- Mortgage securities and similar investments: Agency Securities $ 91,769 $ 102,181 $ 36,626 Non-agency Securities 4,270 5,458 6,900 CMBS and other commercial loans 5,598 2,106 2,350 CMO collateral and investments (1,976) (366) (1,441) -------------- -------------- -------------- Net margin on financial assets 99,661 109,379 44,435 -------------- -------------- -------------- Real estate held for lease: Lease revenue after related interest expense 3,420 -- -- Real estate depreciation (2,543) -- -- -------------- -------------- -------------- Net margin on real estate held for lease 877 -- -- -------------- -------------- -------------- Other revenue (expense): Gain (loss) asset sales 4,725 7,956 (70,173) Impairment on financial assets -- -- (19,088) Severance charges -- -- (3,607) CMO administration and other revenue 2,429 3,705 3,484 Management and affiliate incentive fee (5,986) (9,422) (389) Other operating expense (5,583) (5,342) (6,148) -------------- -------------- -------------- Total other revenue (expense) (4,415) (3,103) (95,921) -------------- -------------- -------------- Net income (loss) $ 96,123 $ 106,276 $ (51,486) ============== ============== ============== Net income (loss) per share: Basic $ 5.47 $ 6.43 $ (6.59) Diluted 4.85 5.68 (6.59) Operating * 5.22 5.55 1.46
* Capstead reports operating income per common share calculated after excluding depreciation on real estate, gain (loss) on asset sales, impairment and severance charges incurred in June 2000, and the dilutive effects of the Series B preferred shares. As such, operating income represents a measure of the amount of funds generated by operations, which may, at the discretion of Capstead's Board of Directors, be used for reinvestment or distributed to common stockholders as dividends. Depreciation on real estate, although an expense deductible for federal income tax purposes and therefore an item that reduces Capstead's REIT distribution requirements, is added back to arrive at operating income because it is a noncash expense. Gains are excluded because they are considered non-operating in nature. Operating income per share excludes the dilutive effects of the Series B preferred shares because it is not economically advantageous to convert these shares at the current market prices of both the common shares and Series B preferred shares (see "Comparison of operating income and diluted income per share"). 2002 COMPARED TO 2001 The earning capacity of Capstead's financial asset portfolios is influenced by the overall size and composition of the portfolios, the relationship between short- and long-term interest rates (the "yield curve") and the extent the Company continues to invest its liquidity in these portfolios. During the past two years, the Company has not added significantly to these portfolios while runoff has been relatively high resulting in declining financial asset CAPSTEAD MORTGAGE CORPORATION portfolio balances. Financial assets that have been acquired during this time period have primarily consisted of adjustable-rate CMBS and other commercial loans, the earnings from which are less sensitive to changes in interest rates. In addition, in May 2002 the Company made its first direct investment in real estate that is net-leased on a long-term basis. Under the terms of the Lease, changes in interest rates on the related debt are the responsibility of the lessee. See "Financial Condition - Mortgage Securities and Similar Investments" and "Real Estate Held For Lease" for further discussion of the current operating environment and the Company's goals regarding redeploying capital made available by portfolio runoff. Net margins on financial assets and related financing spreads (the difference between yields earned on investments and the rates charged on related borrowings) continue to benefit from actions taken by the Federal Reserve during 2001 and again in November 2002 to lower short-term interest rates, which resulted in significantly lower interest rates on the Company's borrowings. However, lower interest rates have also led to declining yields on the Company's adjustable-rate assets and declining portfolio balances primarily caused by higher mortgage prepayment rates. Net margins and spreads are expected to continue declining as yields on the Company's ARM securities continue resetting lower and portfolio balances continue declining because of scheduled principal payments, maturities and relatively high mortgage prepayments (see "Effects of Interest Rate Changes"). Agency Securities remained the primary contributor to operating results in 2002; however, the impact of lower yields and a significantly lower average outstanding portfolio led to lower results for 2002 despite lower borrowing rates. Yields for this portfolio averaged 5.16% during 2002 compared to 6.49% in 2001, while borrowing rates averaged 1.75% during 2002 compared to 4.18% in 2001. The average outstanding Agency Securities portfolio was $2.6 billion during 2002 compared to $4.0 billion during 2001. Similarly, Non-agency Securities contributed less to operating results during 2002 than in 2001. Yields for this portfolio (calculated including mortgage insurance costs) averaged 5.62% during 2002 compared to 7.58% in 2001, while borrowing rates averaged 1.87% in 2002 compared to 3.21% in 2001. The average outstanding portfolio was $91 million during 2002 compared to $87 million in 2001. CMBS and other commercial loans contributed more to operating results during 2002 than in 2001 primarily because of $200 million in portfolio additions since the fourth quarter of 2001. The average outstanding portfolio was $192 million during 2002 compared to $77 million in 2001. The portfolio yielded 4.97% during 2002 while borrowing rates averaged 2.44% producing a financing spread of 2.53%. This compares with yields of 6.46% and borrowing rates of 4.47% for a spread of 1.99% in 2001. Because this portfolio currently consists of adjustable-rate assets secured by borrowings with similar interest rate adjustment features, future changes in short-term interest rates should have little effect on financing spreads (see "Effects of Interest Rate Changes"). CMO collateral and investments contributed less to operating results primarily because of higher prepayments on the underlying pledged CMO collateral. In addition, the portfolio has declined with the exercise of clean-up calls in which the Company has retired related bonds and either sold released CMO collateral for gains or held it as Non-agency Securities. Without the issuance of CMOs in which the Company retains residual interests, or the acquisition of other CMO investments, this portfolio is not expected to provide a positive return on capital employed in future periods other than the potential for gains on sale of released CMO collateral (see "Financial Condition - CMO Collateral and Investments"). CAPSTEAD MORTGAGE CORPORATION Real estate held for lease results reflect ownership of senior living facilities since May 1, 2002. Revenue recognized through July 2002 consisted of accruals under a three-month rent concession. Cash lease payments began in August 2002 (see "Financial Condition - Real Estate Held for Lease" and "Risks Associated with Owning Real Estate"). Gain on asset sales in 2002 reflects the sale of fixed-rate CMO collateral released from related CMOs pursuant to clean-up calls. In addition, a $15 million participation in a one-year secured commercial loan was sold for a gain of $1.9 million shortly after acquisition. This gain effectively accelerated into 2002 much of what would have been earned on this particular investment had it been held to maturity. CMO administration revenue continues to trend lower primarily because a declining portfolio of CMOs for which the Company provides administrative services. As these CMOs pay down, related fee income is expected to decline. Although earnings from overnight investments were significantly less in 2002, other revenue benefited from better than anticipated settlements of liabilities related to the Company's 1998 sale of its servicing operation. Management and affiliate incentive fee reflects the Company's performance against predetermined benchmarks established by members of the Board of Directors that are independent of Fortress (see "NOTE 2" to the accompanying consolidated financial statements). 2001 COMPARED TO 2000 Net margins on financial assets and financing spreads benefited in 2001 from lower short-term interest rates, which resulted in lower interest rates on the Company's borrowings. Yields on ARM securities steadily increased during 2000 and peaked in early 2001 before beginning to reset lower. In addition, lower interest rates spurred higher levels of mortgage prepayments which reduced the overall size of the Company's investment portfolios. Yields also benefited from the sale or designation for sale of nearly all of the Company's fixed-rate and medium-term securities during 2000 and the subsequent acquisition of over $2.3 billion of ARM Agency Securities with the proceeds from these sales. Agency Securities contributed more to operating results during 2001 than in 2000 because of the improvements in financing spreads discussed above, despite a smaller average outstanding portfolio in 2001. Yields for this portfolio averaged 6.49% during the year, compared to 6.59% in 2000, while average borrowing rates were 4.18% compared to 6.30% in 2000. Average yields peaked during the first quarter of 2001 at 7.02% then declined to 5.87% by the fourth quarter. The Agency Securities portfolio averaged $4.0 billion in size during 2001, compared to $5.0 billion in 2000. Non-agency Securities contributed less to operating results during 2001 primarily as a result of a lower average outstanding portfolio. This portfolio averaged $87 million in size during 2001 compared to $152 million in 2000. Average yields for this portfolio (calculated including mortgage insurance costs) were 7.58% during 2001, compared to 7.98% in 2000. The CMBS portfolio contribution to operating results was relatively stable year to year reflecting the benefit of pairing investments with borrowings that have nearly matching interest rate adjustment features. These investments yielded 6.46% during 2001 while borrowing rates averaged 4.47% producing a financing spread of 1.99%. This compares with yields of 9.07% and borrowing rates of 6.94% for a spread of 2.13% during 2000. CAPSTEAD MORTGAGE CORPORATION CMO collateral and investments results continue to diminish as the related CMO securitizations continue to runoff or are redeemed pursuant to clean-up calls. Gain on asset sales reflects sales of $117 million of fixed-rate released CMO collateral and the sale of $451 million of medium-term Agency Securities. CMO administration revenue was lower in 2001 primarily because a declining portfolio of CMOs for which Capstead provides administrative services. Other revenue benefited from investing excess liquidity in short-term investments to take advantage of positive spreads between interest rates on overnight investments and short-term borrowing rates. The management and affiliate incentive fee for 2001 reflects the Company's performance against predetermined benchmarks established by members of the Board of Directors that are independent of Fortress. Other operating expenses were less in 2001 reflecting fewer employees and lower administrative and systems-related costs. LIQUIDITY AND CAPITAL RESOURCES Capstead's primary sources of funds are borrowings under repurchase arrangements and monthly principal and interest payments on mortgage securities and similar investments. Other sources of funds include proceeds from other borrowing arrangements, proceeds from asset sales, payments received on real estate held for lease, and excess cash flows on CMO collateral and investments. The Company generally uses its liquidity to pay down borrowings to reduce borrowing costs. The table included under "Financial Condition - Utilization of Capital and Potential Liquidity" illustrates additional funds potentially available to the Company as of December 31, 2002. The Company currently believes that it has ample liquidity and capital resources available for the acquisition of additional investments, repayments on borrowings and the payment of cash dividends as required for Capstead's continued qualification as a REIT. It is the Company's policy to remain strongly capitalized and conservatively leveraged. Borrowings under repurchase arrangements secured by Agency Securities and Non-agency Securities generally have maturities of less than 31 days. These borrowings totaled approximately $2.0 billion at December 31, 2002. Capstead has uncommitted repurchase facilities with investment banking firms to finance these investments, subject to certain conditions. Interest rates on these borrowings are generally based on 30-day London Interbank Offered Rate ("LIBOR") rates and related terms and conditions are negotiated on a transaction-by-transaction basis. Amounts available to be borrowed under these arrangements are dependent upon the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, credit quality and liquidity conditions within the investment banking, mortgage finance and real estate industries (see "Effects of Interest Rate Changes"). Borrowings under repurchase arrangements with investment banking firms secured by CMBS and from commercial banks secured by investments in commercial loans more closely match the interest rate adjustment features of these investments such that the Company anticipates it can earn more consistent financing spreads and, as a result, experience less interest rate volatility than experienced with investments in Agency Securities. These borrowings, which generally have longer initial maturities than borrowings secured by Agency Securities and may feature renewal options, totaled approximately $128 million at CAPSTEAD MORTGAGE CORPORATION December 31, 2002. Should Capstead make significant additional investments in credit-sensitive assets, it is anticipated that it will attempt to lessen interest rate volatility in a similar fashion or through the use of derivative financial instruments ("Derivatives") such as interest rate swaps (see "Effects of Interest Rate Changes" and "Risks Associated With Credit-Sensitive Investments"). CMO borrowings totaled approximately $1.1 billion at December 31, 2002 and are secured by CMO collateral pledged to the related indentures. As such, recourse is limited to this collateral and therefore has a limited impact on Capstead's liquidity and capital resources. The maturity of each CMO series is affected by mortgage prepayments and clean-up calls. With its acquisition of senior living properties during the second quarter of 2002, Capstead assumed approximately $20 million in long-term mortgage financing from a commercial bank and $101 million in tax-exempt bond debt. In November 2002 the tax-exempt bonds were refunded with the proceeds from issuing new 30-year adjustable-rate tax-exempt bonds (see "Financial Condition - Real Estate Held For Lease"). EFFECTS OF INTEREST RATE CHANGES INTEREST RATE SENSITIVITY ON OPERATING RESULTS The Company performs earnings sensitivity analysis using an income simulation model to estimate the effects that specific interest rate changes can reasonably be expected to have on future earnings. All financial assets and Derivatives held are included in this analysis. The sensitivity of components of Other revenue (expense) to changes in interest rates is included as well, although no asset sales are assumed. Because under the terms of the Lease, Brookdale is responsible for changes in related debt service requirements, earnings from the Company's investment in net-leased real estate are generally not affected by changes in interest rates. The model incorporates management assumptions regarding the level of mortgage prepayments for a given interest rate change using market-based estimates of prepayment speeds for purposes of amortizing investment and liability premiums and discounts. These assumptions are developed through a combination of historical analysis and future expected pricing behavior. As of December 31, 2002 and 2001, Capstead had the following estimated earnings sensitivity profile (dollars in thousands):
10-YEAR 30-DAY U.S. LIBOR TREASURY RATE RATE IMMEDIATE CHANGE IN:* - -------------------------- ------ ---------- ------------------------------------------------------------ 30-day LIBOR rate Down 1.00% Down 1.00% Flat Up 1.00% 10-year U.S. Treasury rate Down 1.00% Flat Up 1.00% Up 1.00% Projected 12-month earnings change:** December 31, 2002 1.38% 3.82% $ 8,484 $11,817 $2,490 $(9,665) December 31, 2001 1.87 5.05 12,380 18,023 3,196 (14,771)
* Sensitivity of earnings to changes in interest rates is determined relative to the actual rates at the applicable date. ** Note that the projected 12-month earnings change is predicated on acquisitions of similar assets sufficient to replace runoff. There can be no assurance that suitable investments will be available for purchase at attractive prices or if investments made will behave in the same fashion as assets currently held. CAPSTEAD MORTGAGE CORPORATION Income simulation modeling is the primary tool used to assess the direction and magnitude of changes in net margins on financial assets resulting from changes in interest rates. Key assumptions in the model include mortgage prepayment rates, changes in market conditions, and management's financial capital plans. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net margins or precisely predict the impact of higher or lower interest rates on net margins. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and other changes in market conditions, management strategies and other factors. GENERAL DISCUSSION OF EFFECTS OF INTEREST RATE CHANGES Changes in interest rates may affect Capstead's earnings in various ways. Earnings currently depend, in part, on the difference between the interest received on mortgage securities and similar investments, and the interest paid on related borrowings, which are generally based on 30-day LIBOR. The resulting financing spread may be reduced or even turn negative in a rising short-term interest rate environment. Because the mortgage securities and similar investments portfolio consists primarily of ARM securities, the risk of rising short-term interest rates is offset to some extent by increases in the rates of interest earned on the underlying ARM loans, which reset periodically based on underlying indices (generally one-year CMT rates). Since only a portion of the ARM loans underlying these securities reset each month, and the terms of an ARM loan generally limit the amount of such increases during any single interest rate adjustment period and over the life of the loan, interest rates on borrowings can rise to levels that may exceed the interest rates on the underlying loans contributing to lower or even negative financing spreads. At other times, declines in these indices during periods of relatively low short-term interest rates will negatively effect yields on ARM securities as the underlying ARM loans reset at lower rates. If declines in these indices exceed declines in the Company's borrowing rates, earnings could be adversely affected. The Company may invest in Derivatives from time to time as a hedge against rising interest rates on a portion of its short-term borrowings. At December 31, 2002, the Company did not own any Derivatives for this purpose. Another effect of changes in interest rates is that as long-term interest rates decrease, the rate of principal prepayments on mortgage loans underlying mortgage securities and similar investments generally increases. During periods of relatively low interest rates, prolonged periods of high prepayments can significantly reduce the expected life of these investments; therefore, the actual yields realized can be lower due to faster amortization of premiums. Further, to the extent the proceeds of prepayments are not reinvested or cannot be reinvested at a rate of interest at least equal to the rate previously earned on that capital, earnings may be adversely affected. There can be no assurance that suitable investments at attractive pricing will be available on a timely basis to replace runoff as it occurs or that the current composition of investments (consisting primarily of ARM Agency Securities) will be maintained. A change in interest rates also impacts earnings recognized from CMO collateral and investments, which currently consist primarily of fixed-rate CMO residuals. During periods of relatively low mortgage interest rates, prepayments on the underlying mortgage loans generally will be higher, accelerating the amortization of collateral and bond premiums. CAPSTEAD MORTGAGE CORPORATION Conversely, if mortgage interest rates rise significantly above interest rates on the collateral, principal prepayments will typically diminish, improving the overall return on an investment in a fixed-rate CMO residual because of an increase in time over which the Company receives positive net cash flows and can amortize remaining collateral and bond premiums. Capstead periodically sells assets, which may increase income volatility because of the recognition of transactional gains or losses. Such sales may become attractive as asset values fluctuate with changes in interest rates. At other times, asset sales may become prudent to shift the Company's investment focus. During periods of rising interest rates or contracting market liquidity, asset values can decline leading to increased margin calls, reducing the Company's liquidity. A margin call means that a lender requires a borrower to pledge additional collateral to re-establish the agreed-upon ratio of the value of the collateral to the amount of the borrowing. If the Company is unable or unwilling to pledge additional collateral, lenders can liquidate the collateral under adverse market conditions, likely resulting in losses. RISKS ASSOCIATED WITH CREDIT-SENSITIVE INVESTMENTS Commercial mortgage assets may be viewed as exposing an investor to greater risk of loss than residential mortgage assets since such assets are typically secured by larger loans to fewer obligors than residential mortgage assets. Commercial property values and related net operating income are often subject to volatility, and net operating income may be sufficient or insufficient to cover debt service on the related mortgage loan at any given time. The repayment of loans secured by income-producing properties is typically dependent upon the successful operation of the related real estate project and the ability of the applicable property to produce net operating income rather than upon the liquidation value of the underlying real estate. Even when the current net operating income is sufficient to cover debt service, there can be no assurance that this will continue to be the case in the future. Additionally, commercial properties may not be readily convertible to alternative uses if such properties were to become unprofitable due to competition, age of improvements, decreased demand, regulatory changes or other factors. The conversion of commercial properties to alternate uses often requires substantial capital expenditures, which may or may not be available. The availability of credit for commercial mortgage loans may be dependent upon economic conditions in the markets where such properties are located, as well as the willingness and ability of lenders to make such loans. The availability of funds in the credit markets fluctuates and there can be no assurance that the availability of such funds will increase above, or will not contract below current levels. In addition, the availability of similar commercial properties, and the competition for available credit, may affect the ability of potential purchasers to obtain financing for the acquisition of properties. This could effect the repayment of commercial mortgages. Credit-sensitive residential mortgage assets differ from commercial mortgage assets in several important ways yet can still carry substantial credit risk. Residential mortgage securities typically are secured by smaller loans to more obligors than CMBS, thus spreading the risk of mortgagor default. However, most of the mortgages supporting credit-sensitive residential securities are made to homeowners that do not qualify for Agency loan programs CAPSTEAD MORTGAGE CORPORATION for reasons including loan size, financial condition, or work or credit history that may be indicative of higher risk of default than loans qualifying for such programs. As with commercial mortgages, in instances of default the Company may incur losses if proceeds from sales of the underlying residential collateral are less than the unpaid principal balances of the residential mortgage loans and related foreclosure costs. However, with residential mortgages this risk may be mitigated by various forms of credit enhancements including, but not limited to, primary mortgage insurance. Through the process of securitizing both commercial and residential mortgages, credit risk can be heightened or minimized. Senior classes in multi-class securitizations generally have first priority over cash flows from a pool of mortgages and, as a result, carry the least risk, highest investment ratings and the lowest yields. Typically, a securitization will also have mezzanine classes and subordinated classes. Mezzanine classes will generally have lower credit ratings, higher yields and may have average lives that are longer than the senior classes. Subordinate classes are junior in the right to receive cash flow from the underlying mortgages, thus providing credit enhancement to the senior and mezzanine classes. As a result, subordinated securities will have even lower credit ratings and higher yields because of the elevated risk of credit loss inherent in these securities. The availability of capital from external sources to finance investments in credit-sensitive commercial and residential mortgage assets may be diminished during periods of mortgage finance market illiquidity. Additionally, if market conditions deteriorate resulting in substantial declines in value of these assets, sufficient capital may not be available to support the continued ownership of such investments, requiring these assets to be sold at a loss. RISKS ASSOCIATED WITH OWNING REAL ESTATE The direct ownership of commercial real estate involves a number of risks. With its first acquisition of real estate, Capstead has attempted to mitigate these risks by entering into a long-term 'net-lease' arrangement whereby the lessee is responsible for the ongoing operation and management of the properties and for paying all expenses associated with the operation of the properties. Although reduced by this net-lease arrangement, risks of ownership remain, including: o The risk that changes in economic conditions or real estate markets may adversely affect the value of the properties. o During inflationary periods, which are generally accompanied by rising interest rates, increases in operating costs and borrowing rates may be greater than increases in lessee revenues from operating properties. Over an extended period of time, this could result in lessee defaults. o The risk that a deterioration of local conditions could adversely affect the ability of a lessee to profitably operate a property. For instance, an oversupply of senior living properties could hamper the leasing of senior living units at favorable rates. This could ultimately affect the value of the properties. o Changes in tax, zoning or other laws could make properties less attractive or less profitable. CAPSTEAD MORTGAGE CORPORATION o An owner cannot be assured that lessees will elect to renew their leases when the terms expire. If a lessee does not renew its lease or otherwise defaults on its lease obligations, there is no assurance the owner can obtain a substitute lessee on acceptable terms. If the owner cannot obtain another qualified operator to lease a property, the owner may be required to modify the property for a different use, which may involve significant capital expenditures and delays in re-leasing the property. o The risk that lessees will not perform under their leases, reducing the owner's income from the leases or requiring the owner to assume costs (such as real estate taxes, insurance, utilities and maintenance) that are the lessees' responsibility under net-leases. In the case of special-purpose real estate such as senior living facilities, compliance with licensing requirements could complicate or delay the transfer of operational control of such properties. This could lead to a significant cash flow burden for the owner to service the debt and otherwise maintain the properties. o Net-leases generally require the lessee to carry comprehensive liability, casualty, workers' compensation and rental loss insurance. The required coverage is typical of the type, and amount, customarily obtained by an owner of similar properties. However, there are some types of losses, such as catastrophic acts of nature, for which insurance cannot be obtained at a commercially reasonable cost. If there is an uninsured loss or a loss in excess of insurance limits, the owner could lose both the revenues generated by the affected property and the capital invested in the property. The owner would, however, remain obligated to repay any mortgage indebtedness or other obligations related to the property. o Investments in real estate are subject to various federal, state and local regulatory requirements including the Americans with Disabilities Act (the "ADA"). The ADA requires that public accommodations reasonably accommodate individuals with disabilities and that new construction or alterations be made to commercial facilities to conform to accessibility guidelines. Failure to comply with the ADA can result in injunctions, fines, and damage awards to private parties and additional capital expenditures to remedy noncompliance. Existing requirements may change and compliance with future requirements may involve significant unanticipated expenditures. Although typically these expenditures would be the responsibility of the lessee under the terms of net-leases, if lessees fail to perform these obligations, the owner may be required to do so. o Under federal, state and local environmental laws, the owner may be required to investigate and clean up any release of hazardous or toxic substances or petroleum products at its properties, regardless of its knowledge or actual responsibility, simply because of current or past ownership of the real estate. If unidentified environmental problems arise, the owner may have to make substantial payments, which could adversely affect cash flow and the ability to make distributions to stockholders. This is so because: 1. The owner may have to pay for property damage and for investigation and clean-up costs incurred in connection with the contamination. 2. The law may impose clean-up responsibility and liability regardless of whether the owner or operator knew of or caused the contamination. Even if more than one person is responsible for the contamination, each person who shares legal liability under environmental laws may be held responsible for all of the clean-up costs. CAPSTEAD MORTGAGE CORPORATION 3. Governmental entities and third parties may sue the owner or operator of a contaminated site for damages and costs. In investigating the acquisition of real estate, environmental studies are typically performed to establish the existence of any contamination. In addition, net-leases generally require lessees to operate properties in compliance with environmental laws and to indemnify the owner against environmental liability arising from the operation of such properties. o An owner may desire to sell a property in the future because of changes in market conditions or poor lessee performance or to avail itself of other opportunities. An owner may also be required to sell a property in the future to meet debt obligations or avoid a default. Unlike investments in mortgage securities, real estate cannot always be sold quickly, and there can be no assurance that the properties can be sold at a favorable price or that a prospective buyer will view existing lease or operating arrangements favorably. In addition, a property may require restoration or modification before it is sold. OTHER CRITICAL ACCOUNTING POLICIES Management's discussion and analysis of financial condition and results of operations is based upon Capstead's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the use of estimates and judgments that can affect the reported amounts of assets, liabilities (including contingencies), revenues and expenses as well as related disclosures. These estimates are based on available internal and market information and appropriate valuation methodologies believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the expected useful lives and carrying values of assets and liabilities which can materially affect the determination of net income and book value per common share. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following are critical accounting policies in the preparation of Capstead's consolidated financial statements that involve the use of estimates requiring considerable judgment: o Amortization of Premiums and Discounts on Financial Assets and Borrowings - Premiums and discounts on financial assets and borrowings are recognized in earnings as adjustments to interest income or interest expense by the interest method over the estimated lives of the related assets or borrowings. For most of Capstead's financial assets, and for its CMO borrowings, estimates and judgments related to future levels of mortgage prepayments are critical to this determination (see "Effects of Interest Rate Changes"). o Fair Value and Impairment Accounting for Financial Assets - Most of Capstead's mortgage securities and similar investments portfolio and a small portion of its CMO collateral and investments portfolio are classified as held available-for-sale and recorded at fair value on the balance sheet with unrealized gains and losses recorded in CAPSTEAD MORTGAGE CORPORATION stockholders' equity as a component of Accumulated other comprehensive income. As such, these unrealized gains and losses enter into the calculation of book value per common share. Generally, gains or losses are recognized in earnings only if sold; however, if a decline in fair value of an individual asset below its amortized cost occurs that is determined to be other than temporary, the difference between amortized cost and fair value would be included in Other revenue (expense) as an impairment charge. Considerable judgment is required interpreting market data to develop estimated fair values, particularly in circumstances of deteriorating credit quality and market liquidity (see "NOTE 10" to the accompanying consolidated financial statements for discussion of how Capstead values its financial assets, "Financial Condition - Risks of Interest Rate Changes" and "- Risks Associated with Credit-Sensitive Investments"). o Depreciation and Impairment Accounting for Real Estate held for Lease - Real estate is carried at cost less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of buildings, equipment and fixtures. If a significant adverse event or change in circumstances occurs, management would assess if the values of the Company's real estate properties have become impaired. If estimated operating cash flows (undiscounted and without interest charges) of a property over its remaining useful life are less than its net carrying value, the difference between net carrying value and fair value would be included in Other revenue (expense) as an impairment charge. Considerable judgment is required in determining useful lives of components of real estate properties and in estimating operating cash flows, particularly during periods of changing circumstances (see "Risks Associated with owning Real Estate"). FORWARD LOOKING STATEMENTS This document contains "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995) that inherently involve risks and uncertainties. Capstead's actual results and liquidity can differ materially from those anticipated in these forward-looking statements because of changes in the level and composition of the Company's investments and unforeseen factors. Relative to the Company's investments in financial assets, these factors may include, but are not limited to, changes in general economic conditions, the availability of suitable investments, fluctuations in, and market expectations for fluctuations in, interest rates and levels of mortgage prepayments, deterioration in credit quality and ratings, the effectiveness of risk management strategies, the impact of leverage, liquidity of secondary markets and credit markets, increases in costs and other general competitive factors. Relative to direct investments in real estate, these factors may include, but are not limited to, lessee performance under lease agreements, changes in general as well as local economic conditions and real estate markets, increases in competition and inflationary pressures, changes in the tax and regulatory environment including zoning and environmental laws, uninsured losses or losses in excess of insurance limits and the availability of adequate insurance coverage at reasonable costs. COMPARISON OF OPERATING INCOME AND DILUTED INCOME (LOSS) PER SHARE The following table compares the calculation of operating income and operating income per common share to net income (loss) and diluted net income (loss) per share (in thousands, except per share amounts):
YEAR ENDED DECEMBER 31 ------------------------------------------------------------------------------------------ 2002 2001 2000 ---------------------------- ---------------------------- ---------------------------- OPERATING DILUTED OPERATING DILUTED OPERATING DILUTED ----------- ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 96,123 $ 96,123 $ 106,276 $ 106,276 $ (51,486) $ (51,486) Adjustments for: Depreciation on real estate 2,543 -- -- -- -- -- Gain (loss) on asset sales (4,725) -- (7,956) -- 70,173 -- Impairment and severance charges -- -- -- -- 22,695 -- Series B preferred dividends (19,954) -- (19,961) (9,981) (20,322) (20,322) Other preferred dividends -- -- -- -- -- (3,938) ----------- ----------- ----------- ----------- ----------- ----------- $ 73,987 $ 96,123 $ 78,359 $ 96,295 $ 21,060 $ (75,746) =========== =========== =========== =========== =========== =========== Weighted average common shares outstanding 13,858 13,858 13,351 13,351 11,487 11,487 Net effect of dilutive securities: Preferred B shares -- 5,652 -- 2,827 -- -- Stock options and other preferred shares 317 317 778 778 2,900 -- ----------- ----------- ----------- ----------- ----------- ----------- 14,175 19,827 14,129 16,956 14,387 11,487 =========== =========== =========== =========== =========== =========== $ 5.22 $ 4.85 $ 5.55 $ 5.68 $ 1.46 $ (6.59) =========== =========== =========== =========== =========== ===========
EX-21 5 d03478exv21.txt LIST OF SUBSIDIARIES EXHIBIT 21 LIST OF SUBSIDIARIES OF CAPSTEAD MORTGAGE CORPORATION At December 31, 2002 the subsidiaries of Capstead Mortgage Corporation were as follows:
STATE OF DOMICILE -------- PARENT COMPANY SUBSIDIARY Capstead Mortgage Corporation ("CMC")..................... Maryland Capstead Capital Corporation........................... Delaware Capstead Securities Corporation IV..................... Delaware CMC Securities Corporation I........................... Nevada CMC Securities Corporation III......................... Delaware CMC Securities Corporation IV.......................... Delaware CMCP Properties, Inc................................... Delaware CMCP - Roswell LLC (1)............................... Delaware CMCP - Williamsburg LLC (1).......................... Delaware CMCP - Pinecastle LLC (1)............................ Delaware CMCP - Montrose LLC (1).............................. Delaware CMCP - Texas, Inc. (1)............................... Delaware CMCP - Club Hill L.P. (2).......................... Texas CMCP - Florida SPE, Inc. (1)......................... Delaware CMCP - Island Lake LLC (3)......................... Delaware Capstead Inc. (4)...................................... Delaware CMC Securities Corporation II (5).................... Delaware
(1) CMC Properties, Inc. owns 100% of the indicated entity. (2) CMCP Properties, Inc. owns 99.99% of the indicated entity with the remainder held by CMCP - Texas, Inc. (3) CMCP - Florida SPE, Inc. owns 100% of the indicated entity. (4) CMC owns all of the issued and outstanding preferred stock. (5) Capstead Inc. owns 100% of the indicated entity. EX-23 6 d03478exv23.txt CONSENT OF ERNST & YOUNG LLP EXHIBIT 23 CONSENT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report on Form 10-K of Capstead Mortgage Corporation of our report dated January 31, 2003, included in the 2002 Annual Report to Stockholders of Capstead Mortgage Corporation. We also consent to the incorporation by reference in the following registration statements and the related prospectuses, of our report dated January 31, 2003, with respect to the consolidated financial statements of Capstead Mortgage Corporation incorporated by reference in this Annual Report on Form 10-K for the year ended December 31, 2002: o Form S-8 (No. 33-40017); o Form S-3 (No. 33-62212); o Form S-8 (No. 33-53555); o Form S-3 (No. 333-03187); o Form S-8 (No. 333-12719); o Form S-3 (No. 333-26419); o Amendment No. 1 to Form S-3 (No. 333-26419); o Form S-8 (No. 333-27215); o Form S-3 (No. 333-43169); o Amendment No. 1 to Form S-3 (No. 333-43169); o Form S-3 (No. 333-63358); and o Form S-3 (No. 333-68424). /s/ ERNST & YOUNG LLP Dallas, Texas March 5, 2003 EX-99.1 7 d03478exv99w1.txt CERTIFICATION PURSUANT TO SECTION 906 EXHIBIT 99.1 CAPSTEAD MORTGAGE CORPORATION CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Capstead Mortgage Corporation (the "Company") on Form 10-K for the period ended December 31, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Wesley R. Edens, Chairman and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1) The report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 7, 2003 By: /s/ WESLEY R. EDENS ------------------------------------- Wesley R. Edens Chairman and Chief Executive Officer In connection with the Annual Report of Capstead Mortgage Corporation (the "Company") on Form 10-K for the period ended December 31, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Andrew F. Jacobs, Executive Vice President - Finance of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1) The report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 7, 2003 By: /s/ ANDREW F. JACOBS ------------------------------------- Andrew F. Jacobs Executive Vice President - Finance -----END PRIVACY-ENHANCED MESSAGE-----