-----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, VaYl5XZbLRlPq76lMoBwgzFbI79RF5QGtLlE0qHnxlMW4HNdBL+qVzQcEgHxR9gG sLSwynczYOihWPXPE5i2dA== 0000950134-98-002033.txt : 19980317 0000950134-98-002033.hdr.sgml : 19980317 ACCESSION NUMBER: 0000950134-98-002033 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980313 SROS: NONE 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: SEC FILE NUMBER: 001-08896 FILM NUMBER: 98565697 BUSINESS ADDRESS: STREET 1: 2711 NORTH HASKELL AVE STREET 2: STE 900 CITY: DALLAS STATE: TX ZIP: 75204 BUSINESS PHONE: 2148742323 MAIL ADDRESS: STREET 1: 2711 NORTH HASKELL AVENUE STREET 2: STE 900 CITY: DALLAS STATE: TX ZIP: 75204 FORMER COMPANY: FORMER CONFORMED NAME: LOMAS MORTGAGE CORP DATE OF NAME CHANGE: 19891105 10-K 1 FORM 10-K FOR YEAR ENDED DECEMBER 31, 1997 1 - -------------------------------------------------------------------------------- ================================================================================ 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, 1997 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.) 2711 NORTH HASKELL, DALLAS, TEXAS 75204 (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 (or for such shorter period that the Registrant was required to file such reports), 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. AT FEBRUARY 16, 1998 THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NONAFFILIATES WAS $1,146,290,000. NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AT FEBRUARY 16, 1998: 59,469,559 DOCUMENTS INCORPORATED BY REFERENCE: (1) PORTIONS OF THE REGISTRANT'S ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1997 ARE INCORPORATED BY REFERENCE INTO PARTS II AND IV. (2) PORTIONS OF THE REGISTRANT'S DEFINITIVE PROXY STATEMENT DATED MARCH 6, 1998, ISSUED IN CONNECTION WITH THE ANNUAL MEETING OF STOCKHOLDERS OF THE REGISTRANT, ARE INCORPORATED BY REFERENCE INTO PART III. - -------------------------------------------------------------------------------- ================================================================================ 2 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES 1997 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS
PAGE ---- PART I ITEM 1. BUSINESS............................................................................ 1 ITEM 2. PROPERTIES.......................................................................... 3 ITEM 3. LEGAL PROCEEDINGS................................................................... 3 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................. 3 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS................................................... 3 ITEM 6. SELECTED FINANCIAL DATA............................................................. 3 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................................... 3 ITEM 3. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................................... 3 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE............................................... 3 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................................. 4 ITEM 11. EXECUTIVE COMPENSATION.............................................................. 4 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................................................. 4 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................................... 4 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K............................................................... 4
3 PART I ITEM 1. BUSINESS. Capstead Mortgage Corporation ("CMC" or the "Company") was incorporated on April 15, 1985 in Maryland and commenced operations in September 1985. The Company's business plan is to build a mortgage banking operation with investments in mortgage servicing and mortgage assets with the goal of producing reasonably balanced operating results in a variety of interest rate environments. Initially, the Company structured and managed mortgage investments. In late 1992 the Company entered into the mortgage servicing business. Mortgage servicing includes collecting and accounting for payments of principal and interest from borrowers, remitting such payments to investors, holding escrow funds for payment of mortgage-related expenses such as taxes and insurance, making advances to cover delinquent payments, inspecting the mortgage premises as required, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, and generally administering the loans. Fees are received for servicing residential mortgage loans ranging generally from 0.25 to 0.38 percent per annum on the declining principal balances of the loans and are collected out of monthly mortgage payments. For further discussion of the Company's business, see the Registrant's Annual Report to Stockholders for the year ended December 31, 1997 on pages 38 through 40. EFFECTS OF INTEREST RATE CHANGES For discussion of effects of interest rate changes on the Company's mortgage securities and mortgage servicing portfolios, see the Registrant's Annual Report to Stockholders for the year ended December 31, 1997 on pages 38, 42 and 43. OTHER INVESTMENT STRATEGIES The Company may enter into other short- or long-term investment strategies as the opportunities arise. COMPETITION In purchasing mortgage securities, the Company competes with savings banks, commercial banks, mortgage and investment bankers, conduits, insurance companies, other lenders and mutual funds. The competition for the acquisition of mortgage servicing rights is primarily with mortgage bankers, commercial banks and savings banks. REGULATION AND RELATED MATTERS The Company's mortgage servicing unit is subject to the rules and regulations of FNMA and FHLMC with respect to servicing mortgage loans. In addition, there are other federal and state statutes and regulations affecting such activities. Moreover, the Company is required annually to submit audited financial statements to FNMA and FHLMC, and each regulatory entity has its own financial requirements. The Company's affairs are also subject to examination by FNMA and FHLMC at all times to assure compliance with applicable regulations, policies and procedures. Many of the aforementioned regulatory requirements are designed to protect the interests of consumers, while others protect the owners or insurers of mortgage loans. Failure to comply with these requirements can lead to loss of approved status, termination of servicing contracts without compensation to the servicer, -1- 4 demands for indemnification or loan repurchases, class action lawsuits and administrative enforcement actions. EMPLOYEES As of December 31, 1997, the Company had 218 full-time employees. TAX STATUS As used herein, "Capstead REIT" refers to CMC and the entities that are consolidated with CMC 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 95 percent 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 the Company'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. 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 1997, capital gains are classified as medium-term on sold assets that were held 12 to 18 months, and long-term on sold assets that were held longer than 18 months. During 1997, 83.7 percent, 7.5 percent, 7.4 percent and 1.4 percent of the common stock distributions were characterized as ordinary income, nontaxable return of capital, medium-term capital gain and long-term capital gain, respectively, while 90.5 percent, 8.6 percent and 0.9 percent of the preferred stock distributions were characterized as ordinary income, medium-term capital gain and long-term capital gain, respectively. During 1996, 83.7 percent, 10.4 percent and 5.9 percent of the common stock distributions were characterized as ordinary income, nontaxable return of capital and long-term capital gain, respectively, while 93.4 percent and 6.6 percent of the preferred stock distributions were characterized as ordinary income and long-term capital gain, respectively. During 1995 all distributions made were characterized as ordinary income. Distributions by the Company will not normally 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. All taxable income of Capstead Holdings, Inc., and its primary subsidiary Capstead Inc. (which conducts mortgage servicing operations), is subject to federal and state income taxes, where applicable. Capstead REIT's taxable income will include earnings of these 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. -2- 5 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. ITEM 2. PROPERTIES. The Company's operations are conducted in Dallas, Texas on properties leased by the Company. ITEM 3. LEGAL PROCEEDINGS. At December 31, 1997 there were no material pending legal proceedings, outside the normal course of business, to which the Company or its subsidiaries were a party or of which any of their property was the subject. ITEM 4. RESULTS OF SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information required by this item is included in the Registrant's Annual Report to Stockholders for the year ended December 31, 1997 on page 36 under the caption "Note 14 - 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 year ended December 31, 1997 on page 37 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, 1997 on pages 38 through 43 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, 1997 on pages 17 through 36, 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. -3- 6 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by this item is included in the Registrant's definitive Proxy Statement dated March 6, 1998 on pages 3 through 6 under the captions "Election of Directors," "Board of Directors" and "Executive Officers," which is incorporated herein by reference pursuant to General Instruction G(3). ITEM 11. EXECUTIVE COMPENSATION. The information required by this item is included in the Registrant's definitive Proxy Statement dated March 6, 1998 on pages 7 through 14 under the captions "Executive Compensation," "Compensation Committee Report on Executive Compensation," and "Performance Graph," 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 definitive Proxy Statement dated March 6, 1998 on pages 16 and 17 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. None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) Documents filed as part of this report: 1. The following financial statements of the Company, included in the 1997 Annual Report to Stockholders, are incorporated herein by reference:
PAGE ---- Consolidated Statement of Income - Years Ended December 31, 1997, 1996 and 1995........................................ * Consolidated Balance Sheet - December 31, 1997 and 1996.................................................... * Consolidated Statement of Stockholders' Equity - Three Years Ended December 31, 1997........................................... * Consolidated Statement of Cash Flows - Years Ended December 31, 1997, 1996 and 1995........................................ * Notes to Consolidated Financial Statements - December 31, 1997............................................................. * 2. Financial statement schedule: Schedule IV - Mortgage Loans on Real Estate..................................... 9
NOTE: All other 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, 1997. -4- 7 PART IV ITEM 14. -- CONTINUED 3. Exhibits: EXHIBIT NUMBER 1.3 Sales Agency Agreement dated as of December 6, 1995 between Capstead Mortgage Corporation and PaineWebber Incorporated (the "Sales Agency Agreement")(6) 1.4 Amendment No. 1 to the Sales Agency Agreement dated as of September 10, 1996 between Capstead Mortgage Corporation and PaineWebber Incorporated (the "Common Stock Sales Agency Agreement")(8) 1.5 Sales Agency Agreement dated as of August 17, 1996 Capstead Mortgage Corporation and PaineWebber Incorporated (the "Series B Preferred Stock 1996 Sales Agency Agreement")(8) 1.6 The Second Amendment dated as of March 4, 1997 to the Sales Agency Agreement dated as of December 6, 1995 between the Company and PaineWebber Incorporated (the "Common Stock Sales Agency Agreement")(9) 1.7 The First Amendment dated as of March 4, 1997 to the Sales Agency Agreement dated as of September 17, 1996 between the Company and PaineWebber Incorporated (the "Series B Preferred Stock 1996 Sales Agency Agreement")(9) 1.8 The Third Amendment dated as of November 17, 1997 to the Sales Agency Agreement dated as of December 6, 1995 between the Company and PaineWebber Incorporated (the "Sales Agency Agreement")(11) 3.1(a) Charter of the Company, which includes Articles of Incorporation, Articles Supplementary for each outstanding Series of Preferred Stock and all other amendments to such Articles of Incorporation(4) 3.1(b) Articles Supplementary ($1.26 Cumulative Convertible Preferred Stock, Series B)(3) 3.2 Bylaws of the Company, as amended(4) 10.21 1990 Employee Stock Option Plan(1) 10.22 1990 Directors' Stock Option Plan(2) Employment Agreement dated August 1, 1992 between Capstead Mortgage Corporation 10.23 and Ronn K. Lytle(3) 10.24 Restricted Stock Grant Agreement dated August 1, 1992 between Capstead Mortgage Corporation and Ronn K. Lytle(3) 10.25 1994 Flexible Long Term Incentive Plan(5) 10.26 1994 Capstead Inc. Restricted Stock Plan(5) 10.27 Capstead Mortgage Corporation Deferred Compensation Plan(5) 10.28 Summary of Employment Agreement dated December 9, 1993 between Capstead Mortgage Corporation and Christopher T. Gilson(5) 10.29 Capstead Mortgage Corporation Incentive Bonus Plan(7) 10.30 Amendment to the 1994 Flexible Long Term Incentive Plan(7) 10.31 Amendment No. 1 dated March 31, 1997 to the Employment Agreement dated August 1, 1992 between the Company and Ronn K. Lytle(10) -5- 8 PART IV ITEM 14. -- CONTINUED 3. Exhibits (continued): EXHIBIT NUMBER 10.32 1997 Flexible Long Term Incentive Plan(10) 11 Computation of per share earnings* 12 Computation of ratio of earnings to combined fixed charges and preferred stock dividends* 13 Portions of the Annual Report to Stockholders of the Company for the year ended December 31, 1997* 21 List of subsidiaries of the Company* 23 Consent of Ernst & Young LLP, Independent Auditors* 27 Financial Data Schedule (electronic filing only)* (1) Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 33-40016) dated April 29, 1991 (2) Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 33-40017) dated April 29, 1991 (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (4) Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 33-62212) dated May 6, 1993 (5) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 (6) Incorporated by reference to the Company's Current Report of Form 8-K dated December 6, 1995 (7) Incorporated by reference to the Company's 10-Q for the quarterly period ended March 31, 1996 (8) Incorporated by reference to the Company's Current Report of Form 8-K dated August 20, 1996 (9) Incorporated by reference to the Company's Current Report of Form 8-K dated March 26, 1997 (10) Incorporated by reference to the Company's 10-Q for the quarterly period ended March 31, 1997 (11) Incorporated by reference to the Company's Current Report of Form 8-K dated December 23, 1997 * Filed herewith (b) Reports on Form 8-K: Current Report on Form 8-K dated December 22, 1997 to file the following: Exhibit 1.8 - The Third Amendment dated as of November 17, 1997 to the Sales Agency Agreement dated as of December 6, 1995 between the Company and PaineWebber Incorporated (the "Sales Agency Agreement"). (c) Exhibits - The response to this section of ITEM 14 is submitted as a separate section of this report. (d) Financial Statement Schedules - The response to this section of ITEM 14 is submitted as a separate section of this report. -6- 9 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 10, 1998 By: /s/ ANDREW F. JACOBS --------------------------------- Andrew F. Jacobs Senior Vice President-Control, Treasurer and Secretary 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/ RONN K. LYTLE Chairman, Chief March 10, 1998 - ------------------------------- Executive Officer (Ronn K. Lytle) and Director /s/ ANDREW F. JACOBS Senior Vice President- March 10, 1998 - ------------------------------- Control, Treasurer (Andrew F. Jacobs) and Secretary /s/ BEVIS LONGSTRETH Director March 11, 1998 - ------------------------------- (Bevis Longstreth) /s/ PAUL M. LOW Director March 12, 1998 - ------------------------------- (Paul M. Low) /s/ HARRIET E. MIERS Director March 11, 1998 - ------------------------------- (Harriet E. Miers) /s/ WILLIAM R. SMITH Director March 10, 1998 - ------------------------------- (William R. Smith) /s/ JOHN C. TOLLESON Director March 11, 1998 - ------------------------------- (John C. Tolleson)
-7- 10 PORTIONS OF THE ANNUAL REPORT ON FORM 10-K ITEMS 14(A)(1), (2) AND (3) FINANCIAL STATEMENT SCHEDULES AND EXHIBITS YEAR ENDED DECEMBER 31, 1997 CAPSTEAD MORTGAGE CORPORATION DALLAS, TEXAS -8- 11 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES SCHEDULE IV -- MORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1997
PART 1 - MORTGAGE LOANS ON REAL ESTATE AT CLOSE OF PERIOD(1) - -------------------------------------------------------------------------------------- COLUMN A COLUMN B COLUMN C - ----------------------------------------------- -------- --------------- PRIOR CARRYING AMOUNT DESCRIPTION LIENS OF MORTGAGES(2) - ----------------------------------------------- ----- --------------- $ -0- - $ 49,999( 3) .................... None $ 99,000 $ 50,000 - $ 99,999( 11) .................... None 901,000 $100,000 - $ 149,999( 33) .................... None 4,437,000 $150,000 - $ 199,999(176) .................... None 32,440,000 $200,000 - $ 249,999(569) .................... None 127,407,000 $250,000 - $ 299,999(304) .................... None 83,280,000 $300,000 - $ 349,999(145) .................... None 47,076,000 $350,000 - $ 399,999( 98) .................... None 36,917,000 $400,000 - $ 449,999( 47) .................... None 20,390,000 $450,000 - $ 499,999( 24) .................... None 11,862,000 $500,000 - $1,500,000( 60) .................... None 35,427,000 ------------ 400,236,000 Plus premium .......................... 1,978,000 Plus unrealized gain on mortgage loans included in debt securities ... 4,651,000 ------------ $406,865,000 ============ PART 2 - INTEREST PART 1 - MORTGAGE LOANS ON REAL ESTATE AT CLOSE OF PERIOD(1) EARNED ON MORTGAGES - --------------------------------------------------------------------------------------------------------- ------------------------ COLUMN A COLUMN D COLUMN E COLUMN F AND COLUMN G(4) - ----------------------------------------------- -------------------------------- ------------- ------------------------ AMOUNT OF PRINCIPAL UNPAID AT CLOSE OF PERIOD --------------------------------- AMOUNT OF SUBJECT TO MORTGAGE DELINQUENT BEING WEIGHTED AVERAGE DESCRIPTION TOTAL INTEREST(3) FORECLOSED(3) INTEREST RATE - ----------------------------------------------- ------------ ------------- ------------- --------------- $ -0- - $ 49,999( 3) .................... $ 99,000 $ 37,000 $ 37,000 8.60% $ 50,000 - $ 99,999( 11) .................... 901,000 78,000 78,000 8.09% $100,000 - $ 149,999( 33) .................... 4,437,000 941,000 268,000 8.15% $150,000 - $ 199,999(176) .................... 32,440,000 3,375,000 1,119,000 8.45% $200,000 - $ 249,999(569) .................... 127,407,000 8,228,000 3,540,000 8.08% $250,000 - $ 299,999(304) .................... 83,280,000 7,327,000 2,449,000 8.09% $300,000 - $ 349,999(145) .................... 47,076,000 6,128,000 1,643,000 8.01% $350,000 - $ 399,999( 98) .................... 36,917,000 2,192,000 722,000 8.44% $400,000 - $ 449,999( 47) .................... 20,390,000 1,278,000 853,000 8.62% $450,000 - $ 499,999( 24) .................... 11,862,000 2,339,000 1,861,000 8.18% $500,000 - $1,500,000( 60) .................... 35,427,000 3,440,000 2,883,000 8.13% ------------ ------------ ------------ $400,236,000 $ 35,363,000 $ 15,453,000 ============ ============ Plus premium .......................... Plus unrealized gain on mortgage loans included in debt securities ...
See accompanying notes to Schedule IV. -9- 12 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES NOTES TO SCHEDULE IV (1) Mortgage loans at December 31, 1997 consisted of single-family, conventional, first mortgage loans most of which are included in AAA-rated private mortgage pass-through securities ("Mortgage Pass-Throughs"). The Company classifies its mortgage loans by interest rate characteristics of the underlying mortgage loans. Fixed-rate mortgage loans (i) have fixed rates of interest for their entire terms, (ii) have an initial fixed-rate period of 10 years after origination and then adjust annually based on a specified margin over 1-year U.S. Treasury Securities ("1-year Treasuries"), or (iii) were previously classified as medium-term and have adjusted to a fixed rate for the remainder of their terms. Medium-term mortgage loans have (i) an initial fixed-rate period of 3 or 5 years after origination and then adjust annually based on a specified margin over 1-year Treasuries, (ii) initial interest rates that adjust one time, approximately 5 years following origination of the mortgage loan, based on a specified margin over Federal National Mortgage Association ("FNMA") yields for 30-year, fixed-rate commitments at the time of adjustment (together referred to as "hybrid securities") or (iii) fixed-rate mortgage securities that have expected weighted average lives of 5 years or less. Adjustable-rate mortgage loans either (i) adjust semiannually based on a specified margin over the 6-month London Interbank Offered Rate ("LIBOR"), (ii) adjust annually based on a specified margin over 1-year Treasuries, or (iii) were previously classified as medium-term and have begun adjusting annually based on a specified margin over 1-year Treasuries. Principal amount of mortgage loans in the portfolio totaling $82,953,000, or 20.4 percent, were fixed-rate loans; $159,337,000, or 39.2 percent, were medium-term loans; and $164,575,000, or 40.4 percent, were adjustable-rate loans. (2) Reconciliation of mortgage loans: Balance at December 31, 1996 (after reclassification to conform to the current-year presentation)................... $493,702,000 Additions: Transfers of mortgage loans from CMO investments................................. 135,607,000 Change in fair value of Mortgage Pass-Throughs............................... 2,202,000 137,809,000 ----------- ----------- 631,511,000 Deductions: Principal collections.................................. 150,604,000 Amortization of discount............................... 715,000 Sales 73,327,000 224,646,000 ------------ ------------ Balance at December 31, 1997................................ $406,865,000 ============
(3) Consists of all mortgage loans delinquent 90 days or more. Note that of the amount of principal unpaid at the close of the period that is subject to delinquent principal, $35.3 million is covered by mortgage pool insurance that effectively limits the Company's loss. Similarly, $7.8 million of the amount of mortgages being foreclosed is covered by pool insurance. (4) Interest due and accrued at the end of the period and interest income earned applicable to the period for each of the categories presented above is not available without unreasonable effort or expense and therefore has been omitted in accordance with Rule 12-23 of Regulation S-X. Total accrued interest for the above listed mortgage loans totaled $2,562,000 at December 31, 1997. -10- 13 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES NOTES TO SCHEDULE IV -- CONTINUED (5) The geographic distribution of the Company's portfolio at December 31, 1997 was as follows:
NUMBER PRINCIPAL STATE OF LOANS AMOUNT ------------------------------------------------------------------ -------- --------- Alabama............................................................. 2 $ 266,000 Arizona............................................................. 4 1,124,000 California.......................................................... 1,172 310,617,000 Colorado............................................................ 5 1,443,000 Connecticut......................................................... 3 768,000 Delaware............................................................ 2 847,000 District of Columbia................................................ 9 3,175,000 Florida............................................................. 29 9,092,000 Georgia............................................................. 31 7,736,000 Hawaii.............................................................. 3 517,000 Illinois............................................................ 8 2,426,000 Indiana............................................................. 1 147,000 Louisiana........................................................... 6 1,707,000 Maryland............................................................ 27 9,240,000 Massachusetts....................................................... 7 1,996,000 Michigan............................................................ 7 3,150,000 Missouri............................................................ 3 1,072,000 Nevada.............................................................. 5 744,000 New Jersey.......................................................... 32 8,089,000 New Mexico.......................................................... 9 2,958,000 New York............................................................ 9 2,780,000 North Carolina...................................................... 2 496,000 Ohio................................................................ 1 366,000 Oklahoma............................................................ 7 1,983,000 Pennsylvania........................................................ 8 3,165,000 Tennessee........................................................... 1 161,000 Texas............................................................... 23 7,294,000 Virginia............................................................ 42 14,798,000 Washington.......................................................... 11 1,947,000 Wisconsin........................................................... 1 132,000 ----- ------------ 400,236,000 Plus premium........................................................ 1,978,000 Plus unrealized gain on mortgage loans included in debt securities....................................... 4,651,000 ------------ Total.......................................................... 1,470 $406,865,000 ===== ============
-11- 14
EXHIBIT NUMBER ------ 1.3 Sales Agency Agreement dated as of December 6, 1995 between Capstead Mortgage Corporation and PaineWebber Incorporated (the "Sales Agency Agreement")(6) 1.4 Amendment No. 1 to the Sales Agency Agreement dated as of September 10, 1996 between Capstead Mortgage Corporation and PaineWebber Incorporated (the "Common Stock Sales Agency Agreement")(8) 1.5 Sales Agency Agreement dated as of August 17, 1996 Capstead Mortgage Corporation and PaineWebber Incorporated (the "Series B Preferred Stock 1996 Sales Agency Agreement")(8) 1.6 The Second Amendment dated as of March 4, 1997 to the Sales Agency Agreement dated as of December 6, 1995 between the Company and PaineWebber Incorporated (the "Common Stock Sales Agency Agreement")(9) 1.7 The First Amendment dated as of March 4, 1997 to the Sales Agency Agreement dated as of September 17, 1996 between the Company and PaineWebber Incorporated (the "Series B Preferred Stock 1996 Sales Agency Agreement")(9) 1.8 The Third Amendment dated as of November 17, 1997 to the Sales Agency Agreement dated as of December 6, 1995 between the Company and PaineWebber Incorporated (the "Sales Agency Agreement")(11) 3.1(a) Charter of the Company, which includes Articles of Incorporation, Articles Supplementary for each outstanding Series of Preferred Stock and all other amendments to such Articles of Incorporation(4) 3.1(b) Articles Supplementary ($1.26 Cumulative Convertible Preferred Stock, Series B)(3) 3.2 Bylaws of the Company, as amended(4) 10.21 1990 Employee Stock Option Plan(1) 10.22 1990 Directors' Stock Option Plan(2) Employment Agreement dated August 1, 1992 between Capstead Mortgage Corporation 10.23 and Ronn K. Lytle(3) 10.24 Restricted Stock Grant Agreement dated August 1, 1992 between Capstead Mortgage Corporation and Ronn K. Lytle(3) 10.25 1994 Flexible Long Term Incentive Plan(5) 10.26 1994 Capstead Inc. Restricted Stock Plan(5) 10.27 Capstead Mortgage Corporation Deferred Compensation Plan(5) 10.28 Summary of Employment Agreement dated December 9, 1993 between Capstead Mortgage Corporation and Christopher T. Gilson(5) 10.29 Capstead Mortgage Corporation Incentive Bonus Plan(7) 10.30 Amendment to the 1994 Flexible Long Term Incentive Plan(7) 10.31 Amendment No. 1 dated March 31, 1997 to the Employment Agreement dated August 1, 1992 between the Company and Ronn K. Lytle(10)
15
EXHIBIT NUMBER ------ 10.32 1997 Flexible Long Term Incentive Plan(10) 11 Computation of per share earnings* 12 Computation of ratio of earnings to combined fixed charges and preferred stock dividends* 13 Portions of the Annual Report to Stockholders of the Company for the year ended December 31, 1997* 21 List of subsidiaries of the Company* 23 Consent of Ernst & Young LLP, Independent Auditors* 27 Financial Data Schedule (electronic filing only)*
(1) Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 33-40016) dated April 29, 1991 (2) Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 33-40017) dated April 29, 1991 (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (4) Incorporated by reference to the Company's Registration Statement on Form S-3 (No. 33-62212) dated May 6, 1993 (5) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1994 (6) Incorporated by reference to the Company's Current Report of Form 8-K dated December 6, 1995 (7) Incorporated by reference to the Company's 10-Q for the quarterly period ended March 31, 1996 (8) Incorporated by reference to the Company's Current Report of Form 8-K dated August 20, 1996 (9) Incorporated by reference to the Company's Current Report of Form 8-K dated March 26, 1997 (10) Incorporated by reference to the Company's 10-Q for the quarterly period ended March 31, 1997 (11) Incorporated by reference to the Company's Current Report of Form 8-K dated December 23, 1997 * Filed herewith EX-11 2 STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE 1 EXHIBIT 11 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES COMPUTATION OF PER SHARE EARNINGS
1997 1996 1995 ------------- ------------- ------------- BASIC:* Average number of common shares outstanding 51,257,000 38,317,000 34,631,000 ============= ============= ============= Net income $ 159,926,000 $ 127,228,000 $ 77,359,000 Less cash dividends paid on convertible preferred stock: Series A ($1.60 paid per share) (683,000) (804,000) (939,000) Series B ($1.26 paid per share) (24,774,000) (35,552,000) (38,395,000) ------------- ------------- ------------- Net income available to common stockholders $ 134,469,000 $ 90,872,000 $ 38,025,000 ============= ============= ============= Basic net income per common share $ 2.62 $ 2.37 $ 1.10 DILUTED:* Average number of common shares outstanding 51,257,000 38,317,000 34,631,000 Assumed conversion of convertible preferred stock: Series A 889,000 1,048,000 1,204,000 Series B 14,776,000 21,176,000 ** Incremental shares calculated using the treasury stock method 1,101,000 960,000 48,000 ------------- ------------- ------------- 68,023,000 61,501,000 35,883,000 ============= ============= ============= Net income $ 159,926,000 $ 127,228,000 $ 77,359,000 Less cash dividends paid on Series B Preferred Stock - - (38,395,000) ------------- ------------- ------------- Net income $ 159,926,000 $ 127,228,000 $ 38,964,000 ============= ============= ============= Diluted net income per common share $ 2.35 $ 2.07 $ 1.09
* AMOUNTS PRIOR TO 1997 HAVE BEEN RESTATED AS REQUIRED TO COMPLY WITH STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 128, "EARNINGS PER SHARE." FOR FURTHER DISCUSSION OF NET INCOME PER COMMON SHARE, SEE THE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS. AMOUNTS HAVE BEEN ADJUSTED FOR 3-FOR-2 COMMON STOCK SPLITS EFFECTIVE OCTOBER 30, 1995 AND JULY 31, 1996. ** THE SERIES B PREFERRED STOCK WAS NOT CONSIDERED CONVERTIBLE FOR PURPOSES OF CALCULATING DILUTED NET INCOME PER SHARE AS IT WAS ANTIDILUTIVE. EX-12 3 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES 1 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES 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 ------------------------------------------------------------ 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- Fixed charges $633,845 $598,312 $584,137 $474,844 $491,076 Preferred stock dividends 25,457 36,356 39,334 38,876 38,592 -------- -------- -------- -------- -------- Combined fixed charges and preferred stock dividends 659,302 634,668 623,471 513,720 529,668 Net income 159,926 127,228 77,359 85,579 94,256 -------- -------- -------- -------- -------- Total $819,228 $761,896 $700,830 $599,299 $623,924 ======== ======== ======== ======== ======== Ratio of earnings to combined fixed charges and preferred stock dividends 1.24:1 1.20:1 1.12:1 1.17:1 1.18:1 ======== ======== ======== ======== ========
(b) Computation of ratio of earnings to combined fixed charges and preferred stock dividends (excluding CMO debt):
YEAR ENDED DECEMBER 31 ------------------------------------------------------------ 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- Fixed charges $352,348 $283,974 $223,751 $139,188 $ 80,923 Preferred stock dividends 25,457 36,356 39,334 38,876 38,592 -------- -------- -------- -------- -------- Combined fixed charges and preferred stock dividends 377,805 320,330 263,085 178,064 119,515 Net income 159,926 127,228 77,359 85,579 94,256 -------- -------- -------- -------- -------- Total $537,731 $447,558 $340,444 $263,643 $213,771 ======== ======== ======== ======== ======== Ratio of earnings to combined fixed charges and preferred stock dividends 1.42:1 1.40:1 1.29:1 1.48:1 1.79:1 ======== ======== ======== ======== ========
EX-13 4 ANNUAL REPORT TO SECURITY HOLDERS 1 EXHIBIT 13 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 1997 2 REPORT OF INDEPENDENT AUDITORS Stockholders and Board of Directors Capstead Mortgage Corporation We have audited the accompanying consolidated balance sheet of Capstead Mortgage Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. 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 generally accepted auditing standards. 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 and subsidiaries at December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Dallas, Texas January 21, 1998 3 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31 --------------------------------------- 1997 1996 1995 --------- --------- --------- INTEREST INCOME: Mortgage investments $ 339,980 $ 303,212 $ 242,805 CMO collateral and investments 354,279 359,752 380,355 --------- --------- --------- Total interest income 694,259 662,964 623,160 --------- --------- --------- INTEREST AND RELATED EXPENSES: Short-term borrowings: Mortgage investments 300,391 255,481 215,308 CMO investments 29,244 12,044 1,342 Collateralized mortgage obligations 281,497 314,338 360,386 Mortgage insurance and other 5,155 7,743 11,385 --------- --------- --------- Total interest and related expenses 616,287 589,606 588,421 --------- --------- --------- Net margin on mortgage assets 77,972 73,358 34,739 --------- --------- --------- MORTGAGE SERVICING REVENUES: Servicing fees 125,954 101,815 68,510 Other 46,962 28,738 19,662 --------- --------- --------- Total mortgage servicing revenues 172,916 130,553 88,172 --------- --------- --------- MORTGAGE SERVICING EXPENSES: Direct servicing expenses 18,016 13,626 10,781 Indirect servicing expenses 7,873 6,561 2,461 Amortization of mortgage servicing rights 64,892 44,795 26,576 Interest 22,713 16,449 7,101 --------- --------- --------- Total mortgage servicing expenses 113,494 81,431 46,919 --------- --------- --------- Net margin on mortgage servicing 59,422 49,122 41,253 --------- --------- --------- OTHER REVENUES: Gain on sales and other 28,485 16,316 12,823 CMO administration 3,252 3,405 3,645 --------- --------- --------- Total other revenues 31,737 19,721 16,468 --------- --------- --------- OTHER OPERATING EXPENSES 9,205 14,973 15,101 --------- --------- --------- NET INCOME $ 159,926 $ 127,228 $ 77,359 ========= ========= ========= Net income $ 159,926 $ 127,228 $ 77,359 Less cash dividends on preferred stock (25,457) (36,356) (39,334) --------- --------- --------- Net income available to common stockholders $ 134,469 $ 90,872 $ 38,025 ========= ========= ========= NET INCOME PER COMMON SHARE: Basic $ 2.62 $ 2.37 $ 1.10 Diluted 2.35 2.07 1.09 AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: Basic 51,257 38,317 34,631 Diluted 68,023 61,501 35,883
See accompanying notes to consolidated financial statements. 4 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31 ------------------------------ 1997 1996 ------------ ------------ ASSETS Mortgage investments $ 6,114,130 $ 4,840,417 CMO collateral and investments 5,195,436 4,501,646 ------------ ------------ 11,309,566 9,342,063 Mortgage servicing rights 684,765 637,979 Prepaids, receivables and other 345,807 156,293 Cash and cash equivalents 17,377 21,003 ------------ ------------ $ 12,357,515 $ 10,157,338 ============ ============ LIABILITIES Short-term borrowings $ 7,099,706 $ 5,462,856 Collateralized mortgage obligations 4,309,455 3,861,892 Accounts payable and accrued expenses 51,323 33,924 Mortgage servicing rights acquisitions payable 8,423 71,797 ------------ ------------ 11,468,907 9,430,469 ------------ ------------ STOCKHOLDERS' EQUITY Preferred stock - $0.10 par value; 100,000 shares authorized: $1.60 Cumulative Preferred Stock, Series A, 408 and 470 shares issued and outstanding ($6,691 aggregate liquidation preference) 5,698 6,567 $1.26 Cumulative Convertible Preferred Stock, Series B, 17,081 and 23,932 shares issued and outstanding ($194,382 aggregate liquidation preference) 189,800 259,829 Common stock - $0.01 par value; 100,000 shares authorized; 58,541 and 44,743 shares issued and outstanding 585 447 Paid-in capital 732,295 461,045 Undistributed income 12,676 4,582 Unrealized loss on debt securities (52,446) (5,601) ------------ ------------ 888,608 726,869 ------------ ------------ $ 12,357,515 $ 10,157,338 ============ ============
See accompanying notes to consolidated financial statements. 5 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY THREE YEARS ENDED DECEMBER 31, 1997 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNDISTRIBUTED UNREALIZED PREFERRED STOCK INCOME GAIN (LOSS) ----------------------- COMMON PAID-IN (ACCUMULATED ON DEBT SERIES A SERIES B STOCK CAPITAL DEFICIT) SECURITIES TOTAL --------- --------- --------- --------- ------------- ---------- --------- Balance at January 1, 1995 $ 8,720 $ 324,779 $ 344 $ 310,782 $ (2,435) $ (78,515) $ 563,675 Net income - - - - 77,359 - 77,359 Cash dividends: Common ($1.09 1/3 per share) - - - - (38,093) - (38,093) Preferred: Series A ($1.60 per share) - - - - (939) - (939) Series B ($1.26 per share) - - - - (38,395) - (38,395) Conversion of preferred stock (1,035) (26) 1 1,060 - - - Additions to capital - 5,312 8 9,380 - - 14,700 Change in unrealized gain (loss) on debt securities - - - - - 86,417 86,417 --------- --------- --------- --------- --------- --------- --------- Balance at December 31, 1995 7,685 330,065 353 321,222 (2,503) 7,902 664,724 Net income - - - - 127,228 - 127,228 Cash dividends: Common ($2.11 1/2 per share) - - - - (83,787) - (83,787) Preferred: Series A ($1.60 per share) - - - - (804) - (804) Series B ($1.26 per share) - - - - (35,552) - (35,552) Conversion of preferred stock (1,118) (79,372) 54 80,412 - - (24) Additions to capital - 9,136 40 59,411 - - 68,587 Change in unrealized gain (loss) on debt securities - - - - - (13,503) (13,503) --------- --------- --------- --------- --------- --------- --------- Balance at December 31, 1996 6,567 259,829 447 461,045 4,582 (5,601) 726,869 Net income - - - - 159,926 - 159,926 Cash dividends: - - - - (126,375) - (126,375) Common ($2.40 per share) Preferred: - - - - (683) - (683) Series A ($1.60 per share) Series B ($1.26 per share) - - - - (24,774) - (24,774) Conversion of preferred stock (869) (84,228) 57 85,040 - - - Additions to capital - 14,199 81 186,210 - - 200,490 Change in unrealized gain (loss) on debt securities - - - - - (46,845) (46,845) --------- --------- --------- --------- --------- --------- --------- Balance at December 31, 1997 $ 5,698 $ 189,800 $ 585 $ 732,295 $ 12,676 $ (52,446) $ 888,608 ========= ========= ========= ========= ========= ========= =========
See accompanying notes to consolidated financial statements. 6 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31 --------------------------------------------- 1997 1996 1995 ----------- ----------- ----------- OPERATING ACTIVITIES: Net income $ 159,926 $ 127,228 $ 77,359 Noncash items: Amortization of premium and discount 114,603 61,520 25,829 Amortization of mortgage servicing rights 64,892 44,795 26,576 Depreciation and other amortization 3,585 3,670 3,260 Net change in prepaids, receivables, other assets, accounts payable and accrued expenses (26,994) 8,364 (17,130) Net gain from investing activities (27,737) (15,991) (11,144) ----------- ----------- ----------- Net cash provided by operating activities 288,275 229,586 104,750 ----------- ----------- ----------- INVESTING ACTIVITIES: Purchases of mortgage investments (4,467,187) (1,813,735) (2,914,774) Purchases of CMO collateral (1,109,412) - - Purchases of CMO investments (574,883) (521,539) (131,531) Purchases of mortgage servicing rights (139,997) (251,505) (184,082) Purchases of derivative financial instruments (112,417) (49,301) (27,381) Principal collections on mortgage investments 1,459,956 975,640 559,046 Proceeds from sales and redemptions of mortgage assets 2,020,450 730,807 1,281,057 Proceeds from sales of derivative financial instruments 34,191 6,782 32,480 CMO collateral: Principal collections 537,817 552,430 491,522 Decrease in accrued interest receivable 4,724 5,119 4,092 Decrease (increase) in short-term investments (4,546) 13,650 4,603 ----------- ----------- ----------- Net cash used by investing activities (2,351,304) (351,652) (884,968) ----------- ----------- ----------- FINANCING ACTIVITIES: Increase in short-term borrowings 1,636,850 834,074 1,438,200 Increase (decrease) in mortgage servicing acquisitions payable (63,374) 23,899 (27,990) Collateralized mortgage obligations: Issuances of securities 1,109,411 41,323 - Principal payments on securities (673,119) (723,881) (572,191) Increase in accrued interest payable 2,253 1,383 1,887 Capital stock transactions 199,214 67,712 14,700 Dividends paid (151,832) (120,143) (77,427) ----------- ----------- ----------- Net cash provided by financing activities 2,059,403 124,367 777,179 ----------- ----------- ----------- Net change in cash and cash equivalents (3,626) 2,301 (3,039) Cash and cash equivalents at beginning of year 21,003 18,702 21,741 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 17,377 $ 21,003 $ 18,702 =========== =========== ===========
See accompanying notes to consolidated financial statements. 7 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 NOTE 1 -- BUSINESS Capstead Mortgage Corporation, a national mortgage banking firm, earns income from servicing mortgage loans, investing in mortgage assets and other investment strategies. The Company's business plan is to build a mortgage banking operation with investments in mortgage servicing and mortgage assets with the goal of producing reasonably balanced operating results in a variety of interest rate environments. NOTE 2 - ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Capstead Mortgage Corporation ("Capstead"), its mortgage servicing subsidiary ("Capstead Inc."), its special-purpose finance subsidiaries and certain other entities (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. Capstead has no responsibility for CMOs beyond the assets pledged as collateral. USE OF ESTIMATES The use of estimates is inherent in the preparation of financial statements in conformity with generally accepted accounting principles. The amortization of premiums and discounts on mortgage assets and CMOs, as well as the amortization of mortgage servicing rights, is based on expectations of future movements in interest rates and how resulting rates will impact prepayments on underlying mortgage loans. Actual results could differ from those estimates. It is possible that prepayments could rise to levels that would adversely affect profitability if such levels are sustained for more than a brief period of time. The Company attempts to mitigate this risk by achieving a balance of investments that perform well in a rising interest rate environment, such as mortgage servicing rights and CMO investments, and in a falling interest rate environment, such as mortgage investments, as supplemented from time to time by hedging activities. MORTGAGE ASSETS Mortgage assets held in the form of mortgage-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 are 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 stockholders' equity. 8 Interest income 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 mortgage asset. Realized gains (losses) are included in other revenues. The cost of assets sold is based on the specific identification method. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. MORTGAGE SERVICING RIGHTS The cost of acquiring mortgage servicing rights is capitalized and amortized in proportion to and over the period of estimated net servicing income. Estimated net servicing income is evaluated periodically and adjustments are made to the rate of amortization. Mortgage servicing rights are evaluated for impairment on a disaggregated basis by predominant risk characteristics. A valuation allowance is established through a charge to income to the extent that the recorded amount for servicing rights within an individual stratum exceeds fair value. Any such valuation allowance may be adjusted in the future, again through a charge or benefit to income, as the fair value of the servicing rights changes. Fair values are established through use of a discounted cash flow valuation model that incorporates assumptions the Company believes market participants would use in estimating the fair value of future net servicing income including assumptions regarding prepayment speeds, discount rates and servicing costs. For impairment evaluation purposes, the Company stratifies its servicing portfolio on the basis of term, interest rate and loan type (fixed-rate versus adjustable-rate). DERIVATIVE FINANCIAL INSTRUMENTS The Company acquires derivative financial instruments ("Derivatives") for trading purposes or as hedges. Derivatives acquired from time to time may include interest rate floors and caps; treasury futures contracts and options; written options on mortgage assets or various other Derivatives available in the market place that are compatible with the Company's risk management objectives. Realized and unrealized gains (losses) on Derivatives held for trading purposes are marked to market through income, while realized and unrealized gains (losses) on Derivatives designated as hedges reduce (increase) the carrying amount of the assets hedged. Ongoing correlation and effectiveness of such Derivatives are measured by comparing the change in value of the hedges with the change in value of the assets hedged. Should a hedge prove ineffective, results in excess of a corresponding change in value of the assets hedged would be taken to income or expense and hedge accounting would cease. The Company primarily uses interest rate floors to protect against increased prepayments on investments in mortgage servicing rights and CMO investments. Interest rate floors increase in value when interest rates decline. To a more limited extent, the Company uses interest rate caps to protect against rising interest rates on short-term borrowings. Interest rate caps increase in value when interest rates increase. Because interest rate floors and caps 9 are one-sided options, the Company's exposure to losses on these instruments is limited to the current basis in the instruments. The Company may receive cash payments from the counterparties to interest rate floors and caps should certain specified interest rates fall below (floors) or rise above (caps) a specified level. Any such payments will be accrued and taken to income as other revenue or, for hedges, as a component of interest income on CMO investments, amortization expense of mortgage servicing rights or interest expense on short-term borrowings, as applicable. The cost of acquiring interest rate floors and caps designated as hedges is taken as a charge to income as a component of the applicable hedged item over the contractual lives of the instruments. The fair value of interest rate floors and the unamortized cost of interest rate caps are included in prepaids, receivables and other on the balance sheet. The Company has credit risk associated with the counterparties to Derivatives. The Company manages credit risk by dealing only with large, financially sound investment banking firms. BORROWINGS CMOs and short-term borrowings are carried at their unpaid principal balances, net of unamortized discount or premium. Any discount or premium is recognized as an adjustment to interest expense by the interest method over the expected term of the related borrowings. MORTGAGE SERVICING REVENUES Mortgage servicing revenues represent fees received for servicing mortgage loans. Servicing fees are calculated based on a contractual percentage of the outstanding monthly principal balance of mortgage loans serviced and are recognized as income when collected. INCOME TAXES Income taxes are accounted for using the liability method, and deferred income tax assets and liabilities are determined based on differences between 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 real estate investment trust ("REIT") subsidiaries have elected to be taxed as a REIT and intend to continue to do so. As a result of this election, Capstead is not taxed on taxable income distributed to stockholders, provided that certain REIT qualification tests are met. It is Capstead's policy to distribute 100 percent 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's non-REIT subsidiaries, principally Capstead Inc., file a separate federal income tax return and are subject to income taxes. STOCK-BASED COMPENSATION Compensation cost for stock-based awards 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 an employee must pay to acquire the stock. 10 NET INCOME PER COMMON SHARE In 1997 the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 replaced the calculation of primary and fully diluted net income per share with basic and diluted net income per share. Unlike primary net income per share, basic net income per share excludes any dilutive effects of options and convertible securities. Diluted net income per share is similar to the previously reported fully diluted net income per share. All net income per share amounts for all periods have been presented and, where appropriate, restated to conform to the SFAS 128 requirements. Basic net income per common share is computed by dividing net income, after deduction of preferred stock dividends, by the weighted average number of common shares outstanding after retroactively giving effect to stock splits. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares and common stock equivalents outstanding, after retroactively giving effect to stock splits, and assuming conversion of the $1.60 Cumulative Preferred Stock, Series A ("Series A Preferred Stock") and the $1.26 Cumulative Convertible Preferred Stock, Series B ("Series B Preferred Stock"). The Series B Preferred Stock was not considered convertible for purposes of calculating diluted net income per common share prior to 1996 because the effects of conversion were antidilutive. RECLASSIFICATION AND STOCK SPLITS Certain amounts for prior years have been reclassified to conform to the 1997 presentation. On October 30, 1995 and July 31, 1996, the Company completed 3-for-2 common stock splits. The affected capital accounts as well as all references to the number of common shares and share amounts in the accompanying consolidated financial statements and related notes have been restated to reflect the stock splits. NOTE 3 - MORTGAGE SERVICING The following table provides information regarding the primary mortgage servicing portfolio (which excludes subservicing) and the related investment in mortgage servicing rights (dollars in thousands):
UNPAID MORTGAGE PRINCIPAL NUMBER SERVICING BALANCE OF LOANS RIGHTS ------------ ------------ ------------ Loans serviced at January 1, 1996 $ 25,557,629 246,885 $ 369,600 Additions 13,663,775 146,527 227,143 Results of hedging activity - - 5,774 Run-off/amortization* (3,658,807) (27,039) (42,660) ------------ ------------ ------------ Loans serviced at December 31, 1996 35,562,597 366,373 559,857 Additions 11,479,030 113,530 218,120 Results of hedging activity - - (33,387) Run-off/amortization* (4,982,600) (38,626) (59,825) ------------ ------------ ------------ Loans serviced at December 31, 1997 $ 42,059,027 441,277 $ 684,765 ============ ============ ============
* EXCLUDES HEDGE INSTRUMENT AMORTIZATION. 11 In addition, the Company subserviced $11.8 billion of single-family mortgage loans under a subservicing arrangement with a large national mortgage conduit as of December 31, 1997. Subsequent to year-end, the Company acquired an additional $934 million of primary mortgage servicing. The Company's investment in mortgage servicing rights had a fair value of approximately $708 million at December 31, 1997. Unrealized gains on interest rate floors held as a partial hedge against declines in value of this investment increased by $33.4 million during 1997 which have been applied to the basis of the servicing rights. Through floor sales, $10.8 million of these gains were realized during 1997. At December 31, 1997 floors held as hedges of servicing rights had related notional amounts totaling $10.9 billion and unrealized gains of $28.3 million. Throughout 1997 and 1996 the fair value of the servicing rights for each stratum of the servicing portfolio exceeded recorded amounts (adjusted for hedging activities); therefore, no impairment charges or direct write-offs of mortgage servicing rights have been recorded. The Company services mortgage loans in all 50 states and the District of Columbia. As of December 31, 1997, 17 percent of loans serviced were located in California (based on the unpaid principal balances). In connection with mortgage servicing activities, the Company maintains segregated escrow deposits that are held in bank trust accounts. At December 31, 1997 and 1996, escrow and fiduciary funds for loans serviced totaled $725 million and $484 million, respectively, and are excluded from the accompanying consolidated balance sheet. NOTE 4 - MORTGAGE INVESTMENTS Mortgage investments and the related average effective interest rates (calculated including mortgage insurance costs and excluding unrealized gains and losses) were as follows (dollars in thousands):
YEAR ENDED AS OF DECEMBER 31 DECEMBER 31 ------------------------- ------------------------- 1997 1996 1997 1996 ---------- ---------- ---------- ---------- Agency securities: Fixed-rate $ 871,377 $ 467,887 6.55% 6.37% Medium-term 616,992 - 6.34 - Adjustable-rate 4,030,460 3,878,827 6.12 6.22 Non-agency securities: Fixed-rate 82,954 69,672 8.59 8.55 Medium-term 347,772 293,230 6.58 7.21 Adjustable-rate 164,575 130,801 7.12 6.67 ---------- ---------- $6,114,130 $4,840,417 ========== ==========
The Company classifies its mortgage investments by interest rate characteristics of the underlying mortgage loans. Fixed-rate mortgage investments either (i) have fixed rates of interest for their entire terms, (ii) have an initial fixed-rate period of 10 years after origination and then adjust annually based on a specified margin over 1-year U.S. Treasury Securities ("1-year Treasuries"), or (iii) were previously classified as medium-term and have adjusted to a fixed rate for the remainder of their terms. Medium-term mortgage investments either have (i) an initial fixed- 12 rate period of 3 or 5 years after origination and then adjust annually based on a specified margin over 1-year Treasuries, (ii) initial interest rates that adjust one time, approximately 5 years following origination of the mortgage loan, based on a specified margin over Federal National Mortgage Association ("FNMA") yields for 30-year, fixed-rate commitments at the time of adjustment, or (iii) fixed-rate mortgage securities that have expected weighted average lives of 5 years or less. Adjustable-rate mortgage investments either (i) adjust semiannually based on a specified margin over the 6-month London Interbank Offered Rate ("LIBOR"), (ii) adjust annually based on a specified margin over 1-year Treasuries, or (iii) were previously classified as medium-term and have begun adjusting annually based on a specified margin over 1-year Treasuries. Agency securities consist of mortgage-backed securities issued by government-sponsored entities, either the Federal Home Loan Mortgage Corporation ("FHLMC"), FNMA or the Government National Mortgage Association (collectively, "Agency Securities"). Non-agency securities consist of AAA-rated private mortgage pass-through and other AAA-rated private mortgage securities (together, "Non-agency Securities"). The maturity of mortgage-backed securities is directly affected by the rate of principal prepayments on the underlying mortgage loans. At December 31, 1997 Agency Securities and Non-agency Securities were pledged to secure short-term borrowings. NOTE 5 - CMO COLLATERAL AND INVESTMENTS CMO collateral consists of mortgage securities and related investments pledged to secure CMO borrowings ("Pledged CMO Collateral"). CMO investments include investments in FNMA and FHLMC Trust interest-only mortgage securities, and investments in other similar interest-only and principal-only mortgage securities. The components of CMO collateral and investments are summarized as follows (in thousands):
DECEMBER 31 --------------------------- 1997 1996 ----------- ----------- Pledged mortgage securities $ 4,326,696 $ 3,908,623 Short-term investments 15,600 11,055 Accrued interest receivable 26,760 24,012 ----------- ----------- 4,369,056 3,943,690 Unamortized premium (discount) 2,752 (7,166) ----------- ----------- Pledged CMO Collateral 4,371,808 3,936,524 FNMA and FHLMC Trust interest-only mortgage securities 809,757 546,539 Other CMO investments 13,871 18,583 ----------- ----------- $ 5,195,436 $ 4,501,646 =========== ===========
Pledged mortgage securities consist primarily of fixed-rate, medium-term and adjustable-rate mortgage-backed securities. All principal and interest on these pledged mortgage securities is remitted directly to a collection account 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 weighted average effective interest rate for total Pledged CMO Collateral was 7.38 percent and 7.40 percent during 1997 and 1996, respectively. 13 FNMA and FHLMC Trust interest-only mortgage securities are entitled to receive 100 percent of coupon interest stripped from pools of FNMA and FHLMC mortgage-backed securities. At December 31, 1997 the Company's investment in FNMA and FHLMC Trust interest-only mortgage securities yielded 7.90 percent with related notional amounts aggregating $2.8 billion. These and certain other CMO investments were pledged to secure short-term borrowings as of December 31, 1997. Unrealized gains on interest rate floors held as a partial hedge against declines in value of CMO investments increased by $54 million during 1997 which have been applied to the basis of the investments hedged. Through floor sales, $9.2 million of these gains were realized during 1997. At December 31, 1997 floors held as hedges of CMO investments had related notional amounts totaling $10.4 billion and unrealized gains of $52.4 million. NOTE 6 - SHORT-TERM BORROWINGS Short-term borrowings are primarily made under repurchase arrangements with investment banking firms pursuant to which the Company pledges mortgage assets as collateral. The terms and conditions of these arrangements, including interest rates, are negotiated on a transaction-by-transaction basis. Repurchase arrangements, all of which had maturities of less than 31 days, and the related average effective interest rates are classified by type of collateral as follows (dollars in thousands):
DECEMBER 31, 1997 DECEMBER 31, 1996 ----------------------- ------------------------- WEIGHTED WEIGHTED BORROWINGS AVERAGE BORROWINGS AVERAGE OUTSTANDING RATE OUTSTANDING RATE ----------- -------- ----------- -------- Agency Securities $5,419,261 5.84% $4,275,701 5.67% Non-agency Securities 582,823 6.12 425,257 5.75 CMO investments 870,816 5.98 581,898 5.90 ---------- ---------- $6,872,900 $5,282,856 ========== ==========
In 1997 Capstead Inc. increased its revolving line of credit agreement with an investment banking firm from $450 million to $625 million and extended the maturity one year to September 30, 1999. A fee was paid on a $275 million committed portion of this facility. The line is used primarily to finance acquisitions of mortgage servicing rights. Interest rates on borrowings under this facility are based on LIBOR with interest due monthly. Borrowings under this facility totaled $179,600,000 at 7.50 percent and $180,000,000 at 8.60 percent at December 31, 1997 and 1996, respectively. In addition, the Company may borrow against Derivative positions on an overnight basis from the counterparties to these instruments. Borrowings under such arrangements totaled $47,206,000 at December 31, 1997 at a weighted average rate of 5.90 percent. There were no such borrowings in 1996. The weighted average effective interest rate on short-term borrowings secured by mortgage assets was 5.53 percent during both 1997 and 1996. Interest paid on short-term borrowings totaled $339,077,000, $279,160,000 and $217,028,000 during 1997, 1996 and 1995, respectively. 14 NOTE 7 - COLLATERALIZED MORTGAGE OBLIGATIONS 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 are summarized as follows (dollars in thousands):
DECEMBER 31 ----------------------------- 1997 1996 ------------ ------------ CMOs $ 4,332,409 $ 3,905,048 Accrued interest payable 63,538 54,548 ------------ ------------ Total obligation 4,395,947 3,959,596 Less unamortized discount (86,492) (97,704) ------------ ------------ $ 4,309,455 $ 3,861,892 ============ ============ Range of average interest rates 5.60% to 9.95% 5.70% to 9.88% Range of stated maturities 2007 to 2027 2007 to 2025 Number of series 33 34
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 at the Company's option provided that certain requirements specified in the related indenture have been met (referred to as "Clean-up Calls"). As a result, the actual maturity of any series is likely to occur earlier than its stated maturity. The average effective interest rate for all CMOs was 7.63 percent and 7.53 percent during 1997 and 1996, respectively. Interest paid on CMOs totaled $263,151,000, $304,670,000 and $351,477,000 during 1997, 1996 and 1995, respectively. NOTE 8 -- DISCLOSURES REGARDING FAIR VALUES OF FINANCIAL INSTRUMENTS Estimated fair values of financial instruments have been determined using available market information and appropriate valuation methodologies; however, considerable judgment is often required in interpreting market data to develop these estimates. In addition, fair values fluctuate on a daily basis. Accordingly, estimates presented herein 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. The carrying amounts of cash and cash equivalents, receivables, payables and short-term borrowings approximate fair value. The fair value of mortgage investments, CMO investments and Derivatives was 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 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 used for determining fair value for the CMO collateral adjusted for credit enhancements. 15 The following table summarizes fair value disclosures for financial instruments (in thousands):
DECEMBER 31, 1997 DECEMBER 31, 1996 ------------------------ ------------------------ CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE --------- --------- --------- --------- ASSETS: Cash and cash equivalents $ 17,377 $ 17,377 $ 21,003 $ 21,003 Receivables 120,542 120,542 74,719 74,719 Mortgage investments 6,114,130 6,115,048 4,840,417 4,842,637 CMO collateral and investments 5,195,436 5,253,299 4,501,646 4,460,497 Derivatives 207,343 203,375 56,049 52,310 LIABILITIES: Payables 59,746 59,746 105,721 105,721 Short-term borrowings 7,099,706 7,099,706 5,462,856 5,462,856 CMOs 4,309,455 4,413,285 3,861,892 3,872,482
The following table summarizes fair value disclosures for available-for-sale debt securities for the periods indicated (in thousands):
GROSS GROSS UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---------- ---------- ---------- ---------- AS OF DECEMBER 31, 1997 Mortgage investments: Agency Securities: Fixed-rate $ 875,928 $ 2,903 $ 7,454 $ 871,377 Medium-term 615,360 1,678 46 616,992 Adjustable-rate 4,017,109 19,850 6,499 4,030,460 Non-agency Securities: Fixed-rate 39,416 878 - 40,294 Medium-term 222,054 398 28 222,424 Adjustable-rate 161,116 3,459 - 164,575 CMO investments 891,213 332 67,917 823,628 ---------- ---------- ---------- ---------- $6,822,196 $ 29,498 $ 81,944 $6,769,750 ========== ========== ========== ========== AS OF DECEMBER 31, 1996 Mortgage investments: Agency Securities: Fixed-rate $ 490,893 $ - $ 23,006 $ 467,887 Adjustable-rate 3,858,339 20,977 489 3,878,827 Non-agency Securities: Fixed-rate 4,144 44 - 4,188 Medium-term 278,473 283 569 278,187 Adjustable-rate 128,110 2,691 - 130,801 CMO collateral and investments 653,748 2,119 7,651 648,216 ---------- ---------- ---------- ---------- $5,413,707 $ 26,114 $ 31,715 $5,408,106 ========== ========== ========== ==========
The Company has the ability to hold mortgage assets for the foreseeable future and, therefore, does not expect to realize losses on security sales. Held-to-maturity debt securities consist of Pledged CMO Collateral and collateral released from related CMO indentures pursuant to Clean-up Calls and held as Non-agency Securities. The following table summarizes fair value disclosures for held-to-maturity debt securities for the periods indicated (in thousands): 16
GROSS GROSS UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---------- ---------- ---------- ---------- AS OF DECEMBER 31, 1997 Pledged CMO Collateral $4,371,808 $ 2,988 $ 48,955 $4,325,841 Non-agency Securities 168,008 918 - 168,926 ---------- ---------- ---------- ---------- $4,539,816 $ 3,906 $ 48,955 $4,494,767 ========== ========== ========== ========== AS OF DECEMBER 31, 1996 Pledged CMO Collateral $3,853,430 $ 3,150 $ 54,889 $3,801,691 Non-agency Securities 80,527 2,314 94 82,747 ---------- ---------- ---------- ---------- $3,933,957 $ 5,464 $ 54,983 $3,884,438 ========== ========== ========== ==========
Sales of released CMO collateral occasionally occur provided the collateral has paid down to within 15 percent of its original issuance amounts. The following table summarizes disclosures related to the disposition of debt securities (in thousands):
1997 1996 1995 ---------- ---------- ---------- Sale of securities held available-for-sale: Amortized cost $1,920,097 $ 624,151 $ 784,600 Gains 24,043 13,936 9,511 Redemption of callable agency notes and sale of released CMO collateral held-to-maturity: Amortized cost 73,324 64,753 320,843 Gains 2,986 1,098 966
NOTE 9 - INCOME TAXES Capstead and its qualified REIT subsidiaries file a separate federal income tax return that does not include the operations of the non-REIT subsidiaries. Provided all taxable income of Capstead and its qualified REIT subsidiaries is distributed to stockholders within time limits prescribed by the Code, no income taxes are due on this income. Taxable income of the non-REIT subsidiaries is fully taxable. Income taxes paid by the non-REIT subsidiaries during 1995 totaled $481,000. No income taxes were paid in 1997 and 1996. Effective tax rates will differ substantially from statutory federal income tax rates because of the effect of the following items (in thousands):
YEAR ENDED DECEMBER 31 ------------------------------------ 1997 1996 1995 -------- -------- -------- Income taxes computed at the federal statutory rate $ 55,974 $ 44,530 $ 27,241 Benefit of REIT status (46,893) (35,384) (21,712) -------- -------- -------- Income taxes computed on income of non-REIT subsidiaries 9,081 9,146 5,529 Alternative minimum tax - - 456 Benefit of previously unrecognized deferred income tax asset (10,889) (8,308) (5,859) Other 1,808 (838) 346 -------- -------- -------- $ - $ - $ 472 ======== ======== ========
17 Significant components of deferred income tax assets and liabilities are as follows (in thousands):
DECEMBER 31 ------------------- 1997 1996 ------- ------- Deferred income tax assets: Net operating loss carryforwards $31,762 $25,947 Hedging transactions 6,660 4,432 Other 1,943 2,834 ------- ------- 40,365 33,213 ------- ------- Deferred income tax liabilities: Mortgage servicing rights 37,276 18,684 Other - 551 ------- ------- 37,276 19,235 ------- ------- Net deferred tax assets $ 3,089 $13,978 ======= ======= Valuation allowance $ 3,089 $13,978 ======= =======
At December 31, 1997 the non-REIT subsidiaries had net operating loss carryforwards for tax purposes of approximately $95 million, which expire beginning in the year 2007. NOTE 10 - STOCKHOLDERS' EQUITY The Series A Preferred Stock is entitled to a cumulative fixed dividend at an annual rate of $1.60, is eligible for conversion into 2.0421 shares of common stock and is nonvoting. The Series A Preferred Stock is currently redeemable at the Company's option at a redemption price of $16.40. During 1997, 62,109 shares of the Series A Preferred Stock were converted into 126,779 shares of common stock. The Series B Preferred Stock is entitled to a cumulative fixed dividend at an annual rate of $1.26, is eligible for conversion into 0.7246 of 1 share of common stock and is nonvoting. The Series B Preferred Stock is currently redeemable at the Company's option at a redemption price of $12.50. During 1997, 7,683,296 shares of the Series B Preferred Stock were converted into 5,566,746 shares of common stock. The weighted average shares used to calculate diluted net income per common share differs from weighted average common shares outstanding because of the dilutive effects of stock options and the potential conversion of preferred stock into common stock. Dilutive options increased weighted average shares by 1,101,000; 960,000 and 48,000 shares in 1997, 1996 and 1995, respectively. In 1997 and 1996 the assumed conversion of the Series A and B Preferred Stock increased weighted average shares by 15,665,000 and 22,224,000 shares, respectively. In 1995, only the Series A Preferred Stock was dilutive, the assumed conversion of which increased weighted average shares by 1,204,000 shares. 18 The Company utilizes several programs designed to raise new equity capital at favorable prices in order to enhance growth prospects for all stockholders. The following table summarizes capital raised through these programs for the periods indicated (dollars in thousands):
1997 1996 1995 --------------------- ---------------------- ------------------- NET NET NET SHARES PROCEEDS SHARES PROCEEDS SHARES PROCEEDS --------- -------- --------- -------- ------- -------- COMMON STOCK: Dividend reinvestments 810,791 $ 18,195 413,030 $ 8,326 156,227 $ 2,044 Direct stock purchases 2,565,434 63,121 647,289 12,091 458,654 6,223 Structured equity shelf 4,108,900 97,938 1,954,550 37,443 64,200 974 --------- -------- --------- ------- ------- ------- 7,485,125 179,254 3,014,869 57,860 679,081 9,241 ========= -------- ========= ------- ======= ------- SERIES B PREFERRED STOCK: Dividend reinvestments 185,523 3,120 310,434 4,259 411,142 5,312 Structured equity shelf 646,500 11,079 309,200 4,877 - - --------- -------- --------- ------- ------- ------- 832,023 14,199 619,634 9,136 411,142 5,312 ========= -------- ========= ------- ======= ------- $193,453 $66,996 $14,553 ======== ======= =======
Dividend reinvestments allow existing stockholders to convert cash dividends into newly issued shares. Similarly, direct stock purchases allow investors the opportunity to acquire additional shares directly from the Company, subject to certain limitations. Structured equity shelf issuances represent new shares issued by the Company on a daily basis either directly into the market or in larger blocks to qualified buyers, subject to certain limitations. As a result of these programs, book value per share, before unrealized losses on debt securities held available-for-sale, rose from $11.14 per diluted share at December 31, 1994, to $13.12 at December 31, 1997. By profitably employing this additional capital, the Company has significantly enhanced its earnings capacity in aggregate and, more importantly, on a per share basis. Option exercises by employees during 1997, 1996 and 1995 resulted in net additions to capital of $5,761,000, $7,246,000 and $147,000, respectively. During 1996 a 6-year option issued in 1992 to acquire 1,687,500 shares of common stock at $14.50 per share was reacquired from a non-affiliated holder at a cost of $6,506,000. The Company's Charter provides that if the Board of Directors determines in good faith that the direct or indirect ownership of stock of Capstead 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 shares of common stock and/or preferred stock sufficient to maintain or bring such ownership into conformity with the Code. In addition, the Company may refuse to transfer or issue shares of common stock and/or preferred stock 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 shares of capital stock 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. NOTE 11 - EMPLOYEE BENEFIT PLANS The Company sponsors stock plans for directors and employees to provide for the issuance of stock options and other incentive-based stock awards (collectively, the "Plans"). The Plans provide for the issuance of up to an 19 aggregate of 7,512,500 shares of common stock. Most of the outstanding stock options provide for the annual granting of dividend equivalent rights ("DERs") that permit the option holder to obtain additional shares of common stock based upon formulas set forth in the Plans (see below) and all options granted have terms and vesting requirements at the grant date of up to ten years. The following table provides information regarding stock option activity for the periods indicated:
NUMBER OF WEIGHTED AVERAGE SHARES EXERCISE PRICE --------- -------------- As of December 31, 1994 (646,243 exercisable) 1,569,278 $13.16 Granted 487,125 11.20 Exercised (17,944) 6.69 Canceled (34,508) 12.80 DERs granted 55,472 - --------- As of December 31, 1995 (1,293,221 exercisable) 2,059,423 12.41 Granted 821,250 15.42 Exercised (563,230) 12.23 Canceled (17,559) 12.01 DERs granted 70,686 - --------- As of December 31, 1996 (1,716,334 exercisable) 2,370,570 13.12 Granted 622,250 23.51 Exercised (431,568) 11.00 Canceled (1,125) 12.00 DERs granted 188,328 - --------- As of December 31, 1997 (1,878,421 exercisable) 2,748,455 14.91 =========
Weighted average exercise price and remaining life information for significant option grants outstanding at December 31, 1997 were as follows:
WEIGHTED AVERAGE OPTIONS OPTIONS EXERCISE REMAINING OUTSTANDING EXERCISABLE PRICE LIFE (YEARS) ----------- ----------- ---------- ------------ Options granted January 1997 622,250 164,000 $ 23.53 9 Options granted January 1996 825,710 413,926 14.41 8 Options granted April 1994 1,089,202 1,089,202 11.07 6
In 1997 and 1996 the Company issued restricted stock grants for 201,000 and 144,000 shares, to all employees at grant date fair values averaging $24.35 and $21.50 per share, respectively, subject to restrictions as to continuous employment. Additionally, in 1996 the Company issued restricted stock grants for 262,500 shares of common stock to key officers at a grant date fair value of $15.42 per share, also subject to restrictions as to continuous employment. Restrictions generally expire over a period of 4 to 10 years from the date of grant. Compensation expense is recognized over the period restricted. At December 31, 1997 a total of 515,400 restricted shares were outstanding under these grants. The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations in accounting for stock awards. Accordingly, no compensation expense has been recognized for stock awards 20 other than for DERs and restricted stock grants. Related compensation costs totaled $6,323,000, $6,032,000 and $798,000 in 1997, 1996 and 1995, respectively. The effect of determining compensation cost for stock options granted since the beginning of 1995, including the accrual for DERs granted in January 1998, based upon the fair value at the grant date consistent with the methodology prescribed under Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," would have been less than 3 cents per year on diluted net income per common share for 1997, 1996 and 1995. This effect on diluted net income per common share was determined using a Black-Scholes option pricing model and, depending upon each individual option grant during the last three years, dividend yields of 10 to 12 percent, volatility factors of 27.8 to 32.5 percent, expected life assumptions of 3 to 5 years and risk-free rates of 5 to over 7 percent. This effect may not be representative of the pro forma effect on future net income. In connection with a restructuring of long-term incentive compensation for key officers, on January 2, 1998 the Company canceled existing DER option grants totaling 452,627 shares (including 231,115 DER shares granted January 2, 1998) and eliminated the right to receive future DER award grants in exchange for cash settlements aggregating $10,524,000 and 452,627 shares of restricted common stock. The restricted stock vests over 5 years and is subject to certain restrictions including continuous employment. This restructuring was fully accrued in 1997 and is expected to result in lower compensation-related accruals in future periods. The Company also sponsors a qualified defined contribution retirement plan for all employees. The Company matches up to 50 percent of a participant's voluntary contribution up to a maximum of 6 percent of a participant's compensation and may make additional contributions of up to another 3 percent of a participant's compensation. All Company contributions are subject to certain vesting requirements. Contribution expenses were $634,000, $677,000 and $759,000 in 1997, 1996 and 1995, respectively. 21 NOTE 12 - NET INTEREST INCOME ANALYSIS (UNAUDITED) The following table summarizes interest income and interest expense on mortgage assets and average effective interest rates for the periods indicated (dollars in thousands):
1997 1996 1995 -------------------- -------------------- ------------------- AVERAGE AVERAGE AVERAGE AMOUNT RATE AMOUNT RATE AMOUNT RATE -------- ------- -------- ------- -------- ------ Interest income: Mortgage investments $339,980 6.28% $303,212 6.41% $242,805 6.51% CMO collateral and investments 354,279 7.84 359,752 7.73 380,355 7.59 -------- -------- -------- Total interest income 694,259 662,964 623,160 Interest expense: Short-term borrowings 329,635 5.53 267,525 5.53 216,650 6.04 CMOs 281,497 7.63 314,338 7.53 360,386 7.57 -------- -------- -------- Total interest expense 611,132 581,863 577,036 - -------- -------- Net interest $ 83,127 $ 81,101 $ 46,124 ======== ======== ========
The following table summarizes the changes in interest income and interest expense due to changes in interest rates versus changes in volume for the periods indicated (in thousands):
1997/1996* 1996/1995* ------------------------------------ ------------------------------------ RATE VOLUME TOTAL RATE VOLUME TOTAL -------- -------- -------- -------- -------- -------- Interest income: Mortgage investments $ (6,163) $ 42,931 $ 36,768 $ (3,936) $ 64,343 $ 60,407 CMO collateral and investments 5,117 (10,590) (5,473) 7,014 (27,617) (20,603) -------- -------- -------- -------- -------- -------- Total interest income (1,046) 32,341 31,295 3,078 36,726 39,804 -------- -------- -------- -------- -------- -------- Interest expense: Short-term borrowings - 62,110 62,110 (19,609) 70,484 50,875 CMOs 4,002 (36,843) (32,841) (2,035) (44,013) (46,048) -------- -------- -------- -------- -------- -------- Total interest expense 4,002 25,267 29,269 (21,644) 26,471 4,827 -------- -------- -------- -------- -------- -------- Net interest $ (5,048) $ 7,074 $ 2,026 $ 24,722 $ 10,255 $ 34,977 ======== ======== ======== ======== ======== ========
* THE CHANGE IN INTEREST 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. 22 NOTE 13 - QUARTERLY RESULTS (UNAUDITED) The following is a summary of quarterly results of operations (in thousands, except percentages and per share amounts):
YEAR ENDED DECEMBER 31, 1997 -------------------------------------------------- FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER -------- -------- -------- -------- Interest income $165,281 $163,015 $175,915 $190,048 Interest and related expenses 143,015 142,902 154,865 175,505 Net margin on mortgage assets 22,266 20,113 21,050 14,543 Net margin on mortgage servicing operations 14,042 13,565 16,253 15,563 Other revenues 3,420 9,549 6,620 12,147 Net income 37,388 39,671 41,867 41,000 Net income per common share:* Basic 0.65 0.67 0.68 0.63 Diluted 0.58 0.60 0.61 0.57 Return on average stockholders' equity 19.76% 19.79% 19.58% 17.81%
YEAR ENDED DECEMBER 31, 1996 -------------------------------------------------- FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER -------- -------- -------- -------- Interest income $166,384 $166,259 $165,104 $165,217 Interest and related expenses 151,006 149,322 145,467 143,816 Net margin on mortgage assets 15,378 16,937 19,637 21,401 Net margin on mortgage servicing operations 9,955 11,164 13,310 14,694 Other revenues 4,754 7,270 2,734 4,965 Net income 26,828 32,173 32,428 35,798 Net income per common share:* Basic 0.47 0.61 0.62 0.66 Diluted 0.45 0.53 0.53 0.57 Return on average stockholders' equity 16.12% 19.01% 18.72% 19.82%
* NET INCOME PER COMMON SHARE AMOUNTS FOR 1996 AND FIRST THREE QUARTERS OF 1997 HAVE BEEN RESTATED TO CONFORM WITH SFAS 128. NOTE 14 - MARKET AND DIVIDEND INFORMATION (UNAUDITED) The New York Stock Exchange trading symbol for the Company's common stock is CMO. There were 3,804 holders of record of the Company's common stock at December 31, 1997. In addition, depository companies held stock for 47,322 beneficial owners. The high and low stock sales prices and dividends declared on common stock for the periods indicated were as follows:
YEAR ENDED DECEMBER 31, 1997 YEAR ENDED DECEMBER 31, 1996 -------------------------------------- -------------------------------------- STOCK PRICES STOCK PRICES --------------------- DIVIDENDS -------------------- DIVIDENDS HIGH LOW DECLARED HIGH LOW DECLARED --------- ------- ---------- -------- ------ ----------- First quarter $ 25 3/8 $19 1/2 $0.58 $17 1/4 $14.42 $0.46 2/3 Second quarter 25 1/4 19 7/8 0.59 1/2 19 1/2 14.33 0.53 1/3 Third quarter 27 13/16 24 1/2 0.61 22 1/2 17.42 0.55 Fourth quarter 27 1/4 17 5/16 0.61 1/2 24 5/8 20 3/4 0.56 1/2
23 CAPSTEAD MORTGAGE CORPORATION AND SUBSIDIARIES SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PERCENTAGES AND PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31 ------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ----------- ----------- ----------- ----------- ----------- SELECTED CONSOLIDATED STATEMENT OF INCOME DATA: Interest income $ 694,259 $ 662,964 $ 623,160 $ 557,001 $ 574,826 Interest and related expenses 616,287 589,606 588,421 488,224 511,160 Net margin on mortgage assets 77,972 73,358 34,739 68,777 63,666 Net margin on mortgage servicing 59,422 49,122 41,253 21,019 (1,056) Gain on sales and other revenues 31,737 19,721 16,468 14,178 64,573 Net income 159,926 127,228 77,359 85,579 94,256 Net income per common share:* Basic $ 2.62 $ 2.37 $ 1.10 $ 1.36 $ 1.64 Diluted 2.35 2.07 1.09 1.34 1.59 Return on average stockholders' equity 19.12% 18.41% 11.91% 13.27% 14.65% Cash dividends paid per share:* Common $ 2.40 $ 2.11 1/2 $ 1.09 1/3 $ 1.42 2/3 $ 1.62 2/3 Series A Preferred 1.60 1.60 1.60 1.60 1.60 Series B Preferred 1.26 1.26 1.26 1.26 1.26 Average number of common shares outstanding:* Basic 51,257 38,317 34,631 34,316 33,871 Diluted 68,023 61,501 35,883 35,720 35,748 SELECTED CONSOLIDATED BALANCE SHEET DATA: Mortgage investments $ 6,114,130 $ 4,840,417 $ 4,556,049 $ 3,310,629 $ 2,875,428 CMO collateral and investments 5,195,436 4,501,646 4,796,925 5,265,458 3,962,679 Mortgage servicing rights 684,765 637,979 423,360 282,969 25,146 Total assets 12,357,515 10,157,338 9,903,606 8,943,858 6,980,324 Short-term borrowings 7,099,706 5,462,856 4,628,782 3,190,582 2,443,807 Collateralized mortgage obligations 4,309,455 3,861,892 4,538,863 5,102,145 3,891,134 Stockholders' equity 888,608 726,869 664,724 563,675 638,190 MORTGAGE SERVICING DATA: Primary servicing portfolio $42,059,027 $35,562,597 $25,557,629 $14,392,182 $ 2,393,267 Subservicing portfolio 11,834,091 2,155,873 - - -
* NET INCOME PER COMMON SHARE AND AVERAGE NUMBER OF COMMON SHARES OUTSTANDING AMOUNTS PRIOR TO 1997 HAVE BEEN RESTATED AS REQUIRED TO COMPLY WITH STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 128, "EARNINGS PER SHARE." FOR FURTHER DISCUSSION OF NET INCOME PER COMMON SHARE, SEE THE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS. AMOUNTS HAVE BEEN ADJUSTED FOR 3-FOR-2 COMMON STOCK SPLITS EFFECTIVE OCTOBER 30, 1995 AND JULY 31, 1996. 24 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION The Company's business plan is to build a mortgage banking operation with investments in mortgage servicing and mortgage assets with the goal of producing reasonably balanced operating results in a variety of interest rate environments. During 1997 long-term mortgage interest rates peaked in late spring and then declined nearly 1 1/2 percentage points by early January 1998 which has spurred prepayments on the Company's mortgage and CMO investments and its mortgage servicing portfolio. In March 1997 the Federal Reserve increased short-term interest rates 1/4 of 1 percentage point and the Company's borrowing rates remained at or above 5 1/2 percent for the remainder of the year. This relatively flat interest rate yield curve environment, where short-term interest rates are equal to long-term interest rates has significantly narrowed the net interest margin earned by the Company on its mortgage investments. Adjustable-rate mortgage ("ARM") mortgage-backed securities have been particularly hard hit by prepayments because homeowners are finding that it has become increasingly advantageous to refinance into lower rate fixed-rate mortgage loans. As a result, purchase premiums paid by the Company for ARM securities must be amortized to income sooner than originally anticipated (see "Effects of Interest Rate Changes"). In light of expected high prepayments on ARM securities, the Company began expanding its investment focus in the third quarter of 1997 to include more medium-term and fixed-rate mortgage securities and more interest rate hedges were acquired to provide additional protection for mortgage servicing and CMO investments should mortgage interest rates continue declining. This restructuring is continuing in the first quarter of 1998. The Company does not believe that the current flat yield curve environment will persist indefinitely and that it will steepen at some point allowing net interest margins to recover to more acceptable levels (see "Effects of Interest Rate Changes"). The Company commenced mortgage servicing operations in 1993 and through steady growth has become one of the 20 largest mortgage servicers in the country with a total mortgage servicing portfolio of $53.9 billion (including primary servicing and subservicing), an increase of $16.2 billion from the prior year. The primary mortgage servicing portfolio (which excludes pending transfers and subservicing) increased to $42.1 billion with a weighted average interest rate of 7.43 percent and earning an average annual service fee, excluding ancillary revenue and earnings on escrows, (the "Average Service Fee") of 30.8 basis points. The December 31, 1997 balance of mortgage servicing rights related to this portfolio was $685 million (163 basis points, or a 5.3 multiple of the Average Service Fee). Primary mortgage servicing portfolio run-off, consisting of prepayments and scheduled payments on mortgage loans serviced, was 12.82 percent in 1997, up from 12.12 percent in 1996. During the fourth quarter of 1997, portfolio run-off increased to 15.11 percent, up from 14.13 percent in the third quarter of 1997, reflecting the recent further decline in mortgage interest rates. Derivative financial instruments, specifically interest rate floors, 25 are held as a partial hedge against prepayment risk (see "Effects of Interest Rate Changes"). Outstanding hedge positions, with a $10.9 billion notional amount, carried a $28.3 million unrealized gain at December 31, 1997 that has been applied to the basis of the Company's investment in mortgage servicing rights. During 1996 the Company entered into a subservicing arrangement with a large national mortgage conduit. As of December 31, 1997, the subservicing portfolio totaled $11.8 billion. An advantage of subservicing arrangements is that further growth and enhanced efficiencies can be achieved without the capital investment and prepayment risk associated with owning additional mortgage servicing rights. This arrangement is viewed by the Company as a confirmation of the quality and cost effectiveness of the mortgage servicing operation and could lead to other such relationships in the future. As of December 31, 1997, holdings of mortgage investments totaled $6.1 billion with ARM mortgage-backed securities representing $4.2 billion of the total. As noted above, beginning in the third quarter of 1997 the Company began acquiring more medium-term and fixed-rate mortgage securities, such that as of December 31, 1997, medium-term and fixed-rate mortgage securities represented 31 percent of total mortgage investments, up from 18 percent at June 30, 1997 and 15 percent at December 31, 1996. During 1997 the Company acquired a total of $4.3 billion of mortgage-backed securities issued by government-sponsored entities, either the Federal Home Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA") or the Government National Mortgage Association (collectively, "Agency Securities") and $190 million of medium-term, AAA-rated fixed-rate private mortgage securities (together with AAA-rated private mortgage pass-through securities, referred to as "Non-agency Securities"). Prior to 1995 the Company had been an active issuer of collateralized mortgage obligations ("CMOs") and other securities backed by jumbo mortgage loans. The Company retained residual interests in these securitizations consisting primarily of interest-only and principal-only mortgage securities. Other than occasional CMO issuances (see below) or modest issuances of previously held residual interests, the Company has not been an active issuer of CMOs since 1994. In lieu of issuing CMOs, the Company has increased its CMO investments (defined as CMO collateral and investments, net of related bonds) by acquiring interest-only mortgage securities. During the year ended December 31, 1997, the Company acquired $575 million of FNMA and FHLMC Trust interest-only mortgage securities, which represent the right to receive 100 percent of coupon interest stripped from pools of FNMA or FHLMC mortgage-backed securities. After considering these acquisitions, CMO issuances, run-off and sales, as well as changes in market value, total CMO investments increased $246 million during 1997 to $886 million. Derivative financial instruments, specifically interest rate floors, are held as a partial hedge against prepayment risk on interest-only mortgage securities (see "Effects of Interest Rate Changes"). Outstanding hedge positions, with a $10.4 billion notional amount, carried a $52.4 million unrealized gain at December 31, 1997 that has been applied to the basis of the Company's investment in interest-only securities. Since the Company exited the jumbo mortgage loan conduit business in 1995, it has maintained several finance subsidiaries with remaining capacity to issue CMOs and other securitizations ("securitization shelves"). In an effort to recover costs associated with these securitization shelves, and to add to the Company's CMO administration activities, the Company may, from time to time, 26 purchase mortgage loans from originators or conduits and issue CMOs or other securities backed by these loans. The Company may or may not retain any residual economic interest in these securitizations. In the latter half of 1997, the Company completed two such CMO transactions totaling $1.1 billion. The following table summarizes the Company's utilization of capital at December 31, 1997 (in thousands):
CAPITAL ASSETS BORROWINGS EMPLOYED ----------- ----------- ----------- Mortgage investments: Agency Securities: Fixed-rate $ 871,377 $ 863,655 $ 7,722 Medium-term 616,992 598,144 18,848 Adjustable-rate 4,030,460 3,957,462 72,998 Non-agency securities: Fixed-rate 82,954 83,955 (1,001) Medium-term 347,772 339,444 8,328 Adjustable-rate 164,575 159,424 5,151 CMO collateral and investments 5,195,436 5,180,271* 15,165 Derivative financial instruments 207,343 47,206 160,137 Mortgage servicing rights 684,765 188,023** 496,742 $12,201,674 $11,417,584 784,090 =========== =========== Other assets, net of other liabilities 104,518 ----------- Total stockholders' equity $ 888,608 ===========
* INCLUDES APPROXIMATELY $871 MILLION OF RELATED SHORT-TERM BORROWINGS. ** REPRESENTS AMOUNTS OWED UNDER CONTRACTS FOR BULK PURCHASES OF MORTGAGE SERVICING RIGHTS AND $179.6 MILLION DRAWN ON A $625 MILLION LINE OF CREDIT SECURED BY EXISTING MORTGAGE SERVICING RIGHTS. During the years ended December 31, 1997 and 1996, the Company raised $200.5 million and $75.1 million, respectively, of new capital through its dividend reinvestment and stock purchase programs, open market sales and stock compensation programs. As a result, book value per common share, before unrealized losses on debt securities held available-for-sale, rose $1.92 during these two years to $13.12 per diluted share at December 31, 1997. The proceeds from these issuances were profitably employed to increase investments in mortgage assets and mortgage servicing, significantly enhancing the Company's earning capacity in aggregate, and more importantly, on a per share basis. Assuming favorable equity market conditions continue, the Company anticipates raising additional capital in 1998. Because the Company distributes virtually all of its net income in dividends, it is important that the Company access the capital markets at favorable prices to continue its growth. Securities held available-for-sale were carried at a net unrealized loss of $52.4 million at December 31, 1997, a net decline of $46.8 million from December 31, 1996. Underlying this change was a $21.6 million increase in value of fixed-rate and medium-term mortgage investments held available-for-sale that was more than offset by a $6.4 million decline in value of ARM investments and a $62 million decline in value of CMO investments held available-for-sale. This reflects the impact of recent declines in mortgage interest rates on market values of these securities, as discussed above, along with purchase and sale activity (see "Effects of Interest Rate Changes"). The Company has the ability to hold mortgage assets for the foreseeable future; therefore, it does not expect to realize losses on security sales. 27 RESULTS OF OPERATIONS Comparative net operating results (interest income or fee revenues, net of related interest expense and, in the case of mortgage servicing and CMO administration, related direct and indirect operating expenses) by source were as follows (in thousands, except percentages and per share amounts):
YEAR ENDED DECEMBER 31 ----------------------------------------- 1997 1996 1995 --------- --------- --------- Agency Securities $ 31,892 $ 35,082 $ 12,589 Non-agency Securities 5,867 9,867 9,743 CMO investments 40,213 28,409 12,407 Mortgage servicing 59,422 49,122 41,253 Gain on sales and other 28,485 16,316 12,823 CMO administration 3,252 3,405 3,645 --------- --------- --------- Contribution to income 169,131 142,201 92,460 Other operating expenses (9,205) (14,973) (15,101) --------- --------- --------- Net income $ 159,926 $ 127,228 $ 77,359 ========= ========= ========= Net income per common share:* Basic $ 2.62 $ 2.37 $ 1.10 Diluted 2.35 2.07 1.09 Return on average stockholders' equity 19.12% 18.41% 11.91%
* NET INCOME PER COMMON SHARE FOR ALL PERIODS HAS BEEN PRESENTED IN CONFORMITY WITH THE PROVISIONS OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 128 "EARNINGS PER SHARE." 1997 COMPARED TO 1996 Operating results for 1997 reached record levels easily surpassing 1996 results. Net income of $159.9 million represents an increase of 25.7 percent over the prior year while diluted net income per common share increased 13.5 percent. Much of the improvement in operating results is attributable to the profitable investment of new capital raised over the past two years into mortgage assets and mortgage servicing. However, the benefit of larger holdings of mortgage assets was offset somewhat by a narrowing of financing spreads due to high levels of prepayments and higher short-term borrowing rates (see above, "Financial Condition"). Likewise, mortgage servicing results, while benefiting from significant growth in the servicing portfolio over the past two years, were hampered to some extent by higher amortization of mortgage servicing rights due to high prepayments. Lower long-term interest rates allowed for greater gain on sales in 1997 compared to prior years. Agency Securities contributed less to income during 1997 than in 1996. The benefit to operating results of an $891 million (22 percent) increase in average holdings of these securities during 1997 was offset by declining financing spreads primarily because of higher prepayments (see above, "Financial Condition"). Additionally, lower 6-month LIBOR and 1-year U.S. Treasury rates have led to declining yields on ARM securities because underlying ARM loans reset periodically to those indexes. Finally, yields on acquisitions of newly created ARM securities have trended lower because many of these securities have initial mortgage interest rates below the referenced indexes (referred to as "teaser-rate ARM securities"). During 1997 financing spreads averaged only 20 basis points lower at 61 basis points; however, financing spreads for the fourth quarter of 1997 were 65 basis points lower at 28 basis points than spreads achieved in the fourth quarter of 1996. Agency 28 Securities yields averaged 6.18 percent during 1997, compared to 6.24 percent during 1996, while borrowing rates were higher at 5.57 percent, compared to 5.43 percent during 1996. Non-agency Securities contributed less to income during 1997 than in 1996 due primarily to a 13 basis point decrease in financing spreads and a 30 percent reduction in the average outstanding portfolio. As a result of asset sales and run-off, the average outstanding portfolio was $476 million during 1997, compared to $682 million in 1996. Average yields for this portfolio (calculated including mortgage insurance costs) were 6.96 percent during 1997, compared to 7.01 percent during 1996, while average borrowing rates were higher at 5.75 percent during 1997, compared to 5.67 percent during 1996. Net CMO investments contributed substantially more to income in 1997 than in 1996 primarily because of substantial investments made during the past two years in interest-only mortgage securities (see above, "Financial Condition"). Average holdings of interest-only mortgage securities increased over 100 percent during 1997 to $723 million from $346 million during 1996, while average yields for this portfolio (after hedging costs) declined to 10.24 percent during 1997 from 11.85 percent during 1996. Yields were negatively impacted by higher prepayments and increased hedging costs. Higher mortgage servicing results reflect continued growth in this operation (see above, "Financial Condition"). Revenues increased to $173 million in 1997, compared to $131 million in 1996. Servicing expenses also increased, but not to the same extent as revenues, reflecting further efficiencies gained in the servicing process with continued growth in the servicing portfolio. Amortization of mortgage servicing rights of $65 million during 1997 was higher than the $45 million recorded in 1996 due to portfolio growth and higher levels of prepayments caused by lower prevailing mortgage interest rates. Greater use of external borrowings secured by the mortgage servicing portfolio to finance portfolio growth contributed to higher borrowing costs in 1997 compared to 1996. Operating expenses during 1997 were lower than 1996 primarily because of lower compensation-related accruals. During 1997 the Company sold $2.0 billion of mortgage assets consisting of Agency Securities, Non-agency Securities and interest-only mortgage securities for gains totaling $27.0 million. This compares to sales of mortgage assets totaling $667 million during 1996 for gains of $14.9 million. Derivative financial instruments held for trading purposes contributed $708,000 to operating results during 1997 compared to $1.1 million during 1996. These instruments (primarily interest rate floors) tend to decrease in value in a rising interest rate environment and increase in value when interest rates fall (see "Effects of Interest Rate Changes"). 1996 COMPARED TO 1995 Operating results for 1996 improved substantially over those achieved in 1995. Improved interest spreads on a larger mortgage investment portfolio, together with improved mortgage servicing results, contributed to significantly higher net income compared to 1995. Modest 1/4 of 1 percentage point reductions in short-term interest rates by the Federal Reserve in July and December 1995 and again in January 1996 contributed to improved interest spreads by lowering average borrowing rates by nearly 1/2 of 1 percentage point to 5.53 percent. Investment yields remained fairly steady. Increased investments in interest-only mortgage securities also contributed to the Company's improved profitability. 29 Higher mortgage servicing results reflected an over 47 percent increase in the total mortgage servicing portfolio to $37.7 billion at December 31, 1996. Revenues increased to $131 million in 1996, compared to $88 million in 1995. Servicing expenses also increased, but not to the same extent as revenues, reflecting efficiencies gained in the servicing process with the strong servicing portfolio growth. Amortization of mortgage servicing rights of $45 million during 1996 was higher than the $27 million recorded in 1995 due to portfolio growth and higher levels of prepayments caused by lower prevailing mortgage interest rates. Greater use of external borrowings secured by the mortgage servicing portfolio to finance portfolio growth contributed to higher borrowing costs in 1996 compared to 1995. Operating expenses in 1996 were marginally lower than in 1995 despite higher compensation-related accruals because of the November 1995 closure of a mortgage conduit unit and, to a lesser extent, the closure of a telephone origination unit in the second quarter of 1996. These two decisions also reduced requirements for loan loss provisions. In addition, with the growth of the mortgage servicing operation, more indirect operating costs were identified with that unit than in 1995. During 1996 the Company sold $667 million of mortgage assets compared to sales in 1995 totaling $1.0 billion. Higher gain on sales reflects lower interest rates experienced during 1996. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of funds include monthly principal and interest payments on mortgage investments, short-term borrowings, excess cash flows on CMO investments, servicing fees and other revenue from mortgage servicing, proceeds from sales of mortgage assets and equity offerings (see above, "Financial Condition"). The Company currently believes that these funds are sufficient for growth of the mortgage servicing portfolio, the acquisition of mortgage assets, repayments on short-term borrowings, the payment of cash dividends as required for Capstead's continued qualification as a Real Estate Investment Trust ("REIT") and common stock repurchases, if any, as described below. It is the Company's policy to remain strongly capitalized and conservatively leveraged. Short-term borrowings are primarily made under repurchase arrangements. The Company has uncommitted repurchase facilities with investment banking firms to finance mortgage assets, subject to certain conditions. Interest rates on borrowings under these facilities are based on overnight to 30-day London Interbank Offered Rate ("LIBOR") rates. The terms and conditions of these arrangements, including interest rates, are negotiated on a transaction-by-transaction basis. At December 31, 1997 the mortgage servicing operation had available $445 million of a $625 million revolving line of credit agreement with an investment banking firm that matures September 30, 1999. The line is to be used primarily to finance acquisitions of mortgage servicing rights on a collateralized basis. The agreement requires, among other things, that the mortgage servicing operation maintain certain financial ratios and specified levels of unencumbered servicing rights. The mortgage servicing operation is in compliance with all requirements. Interest rates on borrowings under this facility are based on LIBOR. 30 In 1996 the board of directors of the Company approved the repurchase of up to 1 million shares of common stock to fund employee stock option and stock grant programs. As of December 31, 1997 no such share repurchases had occurred. EFFECTS OF INTEREST RATE CHANGES Changes in interest rates may impact the Company's earnings in various ways. The Company's earnings depend, in part, on the difference between the interest received on mortgage investments and the interest paid on related short-term borrowings. The resulting spread may be reduced in a rising interest rate environment. Because a substantial portion of the Company's mortgage investments are ARM mortgage securities, the risk of rising short-term interest rates is offset to some extent by increases in the rates of interest earned on underlying ARM loans. Since ARM loans generally limit the amount of such increase 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 ARM loans resulting in a negative financing spread. The Company may invest in derivative financial instruments ("Derivatives") from time to time, specifically interest rate caps, as a hedge against rising interest rates on a portion of its short-term borrowings. Interest rate caps increase in value as related interest rates rise and decline in value when such rates fall. Another effect of changes in interest rates is that, as interest rates decrease, the rate of prepayment of mortgage loans underlying mortgage investments generally increases. To the extent the proceeds of prepayments on mortgage investments cannot be reinvested at a rate of interest at least equal to the rate previously earned on such investments, earnings may be adversely affected. Because prolonged periods of high prepayments can significantly reduce the expected life of mortgage investments, the actual yields realized can be lower due to faster amortization of purchase premiums. In addition, the rates of interest earned on ARM investments generally will decline during periods of falling interest rates as the underlying ARM loans reset at lower rates. The Company may, from time to time, sell mortgage assets. This may increase income volatility because of the recognition of transactional gains or losses. Such sales may become attractive as values of mortgage assets fluctuate with changes in interest rates. Changes in interest rates also impact earnings recognized from CMO investments, which consist primarily of fixed-rate CMO residuals and interest-only mortgage securities. The amount of income that may be generated from the typical CMO residual is dependent upon the rate of principal prepayments on the underlying mortgage collateral. If mortgage interest rates fall significantly below interest rates on the collateral, principal prepayments will increase, reducing or eliminating the overall return on the investment in the CMO residual. This is due primarily to the acceleration of the amortization of bond discounts, a noncash item, as bond classes are repaid more rapidly than originally anticipated. 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 the larger positive interest spread. 31 Interest-only mortgage securities behave similarly to CMO residuals. In a falling interest rate environment, prepayments on the underlying mortgage loans generally will be higher thereby reducing or even eliminating overall returns on these securities. Sustained periods of high prepayments can result in losses. Conversely, in periods of rising interest rates, interest-only mortgage securities tend to perform favorably because underlying mortgage loans will generally prepay at slower rates thereby increasing overall returns. The above discussion regarding how changes in interest rates impact mortgage assets also applies to the Company's investment in mortgage servicing rights. When interest rates rise, periodic amortization of amounts paid for mortgage servicing rights is less since the average lives of the related mortgage loans tend to be longer and earnings from temporarily held cash balances will be greater. Under these conditions, mortgage servicing rights become more valuable. Conversely, lower interest rates will spur prepayments thus reducing the time the Company can service the related loans. Sustained periods of high prepayments can result in losses on the Company's investment in mortgage servicing rights, particularly since this investment is evaluated for impairment on a disaggregated basis and impairment charges are necessary if the recorded amount for an individual servicing stratum exceeds its fair value. The Company's business plan is to build a mortgage banking operation with investments in mortgage servicing and mortgage assets with the goal of producing reasonably balanced operating results in a variety of interest rate environments. The Company supplements its business plan from time to time with Derivatives held for trading purposes or to hedge certain assets, principally interest-only mortgage securities and mortgage servicing rights. Most Derivatives used by the Company are interest rate floors that decrease in value when interest rates rise and increase in value when rates decline. Other Derivatives acquired from time to time may include interest rate caps, treasury futures contracts and options, written options on mortgage assets or various other Derivatives available in the market place that are compatible with the Company's risk management objectives. In instances where such Derivatives are designated as hedges, any changes in value will adjust the basis of the assets hedged. In instances where Derivatives are held for trading purposes, changes in value will be recorded in income as they occur, which could increase income volatility. OTHER Many existing computer software programs use only two digits to identify the year in date fields and, as such, could fail or create erroneous results by or at the Year 2000. The Company utilizes a number of software systems to service mortgage loans, administer securitizations and manage its mortgage assets. The Company has made and will continue to make investments in its software systems and applications to ensure the Company is Year 2000 compliant. In addition, the Company has taken steps to ensure that the vendors it utilizes in various capacities and institutions that it interfaces with are also taking the necessary steps to become Year 2000 compliant. This process is expected to be essentially complete by mid-1998. The financial impact of becoming Year 2000 compliant has not been and is not expected to be material to the Company or results of operations. This document contains "forward-looking statements" (within the meaning of the Private Securities Litigation Act of 1995) that inherently involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of unforeseen external factors. These factors may include, but are not limited to, changes in general economic conditions, fluctuations in interest rates, increases in costs and other general competitive factors. EX-21 5 SUBSIDIARIES OF THE REGISTRANT 1 EXHIBIT 21 LIST OF SUBSIDIARIES OF CAPSTEAD MORTGAGE CORPORATION At December 31, 1997 the subsidiaries of Capstead Mortgage Corporation were as follows:
STATE OF DOMICILE -------- PARENT COMPANY SUBSIDIARY Capstead Mortgage Corporation ("CMC")................................................... Maryland Capstead Advisers, Inc............................................................... Nevada Capstead Capital Corporation......................................................... Delaware Capstead Select Corporation.......................................................... Delaware Capstead Securities Corporation I.................................................... Delaware Capstead Securities Corporation II................................................... Delaware Capstead Securities Corporation III.................................................. Delaware Capstead Securities Corporation IV................................................... Delaware CMC Securities Corporation I......................................................... Nevada CMC Securities Corporation III....................................................... Delaware CMC Securities Corporation IV........................................................ Delaware CMC ARM Securities Corporation....................................................... Delaware Capstead Mortgage Services Corporation............................................... Delaware Capstead Holdings, Inc.(1)........................................................... Delaware Capstead Inc.(2)................................................................... Delaware CMC Securities Corporation II(2)................................................... Delaware CMC Investment Partnership(3)........................................................... Texas
(1) CMC owns all of the issued and outstanding preferred stock. (2) Capstead Holdings, Inc. owns all the issued and outstanding common stock. (3) A general partnership owned by CMC and Capstead Holdings, Inc. EX-23 6 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23 CONSENT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of Capstead Mortgage Corporation of our report dated January 21, 1998, included in the 1997 Annual Report to Stockholders of Capstead Mortgage Corporation. Our audits also included the financial statement schedule of Capstead Mortgage Corporation listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audit. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the following registration statements and the related prospectuses, our report dated January 21, 1998, with respect to the consolidated financial statements incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedule included in the Form 10-K of Capstead Mortgage Corporation: o Form S-8 (No. 33-40116); o Form S-8 (No. 33-40117); o Form S-3 (No. 33-62212); o Form S-3 (No. 33-52415); o Form S-8 (No. 33-53555); o Form S-3 (No. 33-57164); o Form S-3 (No. 333-03187); o Form S-8 (No. 333-12719); o Form S-3 (No. 333-26419); o Form S-3 (No. 333-26865); o A pre-effective amendment to Form S-3 (No. 333-26419); o Form S-8 (No. 333-27215); o A post-effective amendment to Form S-3 (No. 333-26865); and o Form S-3 (No. 333-43169). ERNST & YOUNG LLP Dallas, Texas March 10, 1998 EX-27 7 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from Capstead Mortgage Corporation Annual Report on Form 10-K for the period ended December 31, 1997 and is qualified in its entirety by reference to such financial statements. 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 17,377 0 0 0 0 0 0 0 12,357,515 7,159,452 4,309,455 0 195,498 585 692,525 12,357,515 0 898,912 0 0 105,141 0 633,845 159,926 0 159,926 0 0 0 159,926 2.62 2.35
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