Celebrating 25 years Experienced Management, Quality Assets and Proven Strategy Capstead Mortgage Corporation 2010 Annual Report
How we invest. Capstead invests in a conservatively leveraged portfolio of almost exclusively residential adjustable- rate mortgage (“ARM”) securities issued and guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. Agency-guaranteed mortgage securities are considered to have little, if any, credit risk, particularly in light of the conservatorship of Fannie Mae and Freddie Mac by the federal government in 2008. Capstead’s investment strategy is designed to produce attractive risk- adjusted returns over the long term, while reducing, but not eliminating, sensitivity to changes in interest rates. This strategy differentiates the Company from its peers because ARM securities reset to more current interest rates within a relatively short period of time allowing for: • The recovery of financing spreads diminished during periods of rising interest rates, and • Smaller fluctuations in portfolio values from changes in interest rates compared with portfolios that contain a significant amount of fixed-rate mortgage securities. From a credit-risk perspective, the credit quality of agency-guaranteed mortgage securities helps ensure that fluctuations in value due to credit risk should be limited and financing at reasonable rates and terms should remain available under stressed market conditions.
[ P.1 ] C a p s t e a d M o r t g a g e C o r p o r a t i o n To our Stockholders: Capstead has come a long way in 25 years. In 1985, we were created and listed on the New York Stock Exchange as an outlet for a large mortgage strategy of managing a conservatively banking firm’s nonconforming leveraged portfolio of agency- residential mortgage loan guaranteed adjustable-rate mortgage production, utilizing the real estate (“ARM”) securities that carry an investment trust (“REIT”) model in implied AAA rating with limited, if a novel way. Nonconforming any, credit risk, particularly in light mortgage loans do not qualify for of the conservatorship of the GSEs purchase by Fannie Mae and Freddie by the federal government in 2008. Mac (each a government sponsored Investing in agency-guaranteed enterprise, or “GSE”), or by Ginnie mortgage securities virtually Mae, an agency of the federal eliminates our exposure to the credit government (together, the risk of the underlying mortgage The U.S. REIT industry has come a long “agencies”). In the following years, loans, and our focus on ARM way too, celebrating its 50th anniversary we evolved into one of the largest securities is designed to produce in 2010. nonconforming mortgage loan attractive risk-adjusted returns over conduits and later built a significant the long term while reducing, but not than 18 months, with nearly all of mortgage servicing platform. We eliminating, sensitivity to changes in the remainder consisting of ARM exited the conduit business in 1994 interest rates. At December 31, securities that will reset in rate in in order to avoid residential credit 2010, 88% of our investment three years on average. Our risk, and in 1998 we sold our portfolio consisted of current-reset investment strategy differentiates us mortgage servicing business. In 2000, ARM securities that will adjust to a from our peers because the coupon we adopted our current investment more current rate of interest in less interest rates on mortgage loans FINANCIAL HIGHLIGHTS (In thousands, except per share data) 2010 2009 2008 For the year ended December 31: Net interest margin $ 143,527 $ 185,765 $ 142,036 Net income 126,896 129,263 125,923 Earnings per diluted common share 1.52 1.66 1.93 As of December 31: Mortgage securities and similar investments 8,515,691 8,091,103 7,499,249 Repurchase arrangements and similar borrowings 7,792,743 7,435,256 6,751,500 Long-term investment capital: Unsecured borrowings, net 99,978 99,978 99,978 Stockholders’ equity 1,027,425 1,013,941 760,450
[ P.2 ] C a p s t e a d M o r t g a g e C o r p o r a t i o n underlying current-reset ARM Despite the high level of mortgage securities reset to more current interest prepayments resulting from the GSE rates within a relatively short period of buyout programs, market conditions time, allowing for a recovery of continued to be favorable for investors financing spreads diminished during in agency-guaranteed residential periods of rising interest rates and mortgage securities. Prices for our providing for smaller fluctuations in investment portfolio remained strong, portfolio values from changes in and the availability of financing at interest rates compared with portfolios attractive interest rates remained that contain a significant amount of plentiful. With 2010 portfolio fixed-rate mortgage securities. acquisitions totaling almost $3.3 Not only did we celebrate our billion, we were able to more than REITs were created by the U.S. 25th Anniversary in 2010, but our replace all of the year’s accelerated Congress in 1960 to make real estate operating results were one of the best runoff contributing to an increase in investing available to all investors. in our Company’s history. We reported our investment portfolio to over $8.5 net income of $126.9 million in 2010, billion by the end of 2010. which together with $129.3 million in While our investment strategy 2009 and $125.9 million in 2008, involves a measured use of leverage, makes this the best consecutive three- our experience and discipline in the year period in Capstead’s 25-year history. use of this leverage has allowed us to Over this same three-year period, our successfully navigate the turbulent book value grew 30% to $12.02 per markets seen in recent years. With $7.79 $1.13 billion billion common share from $9.25 per long-term investment capital of over common share at December 31, 2007. $1.1 billion at December 31, 2010, That is not to say 2010 was our portfolio leverage remained 6.91:1 without its challenges. In February, relatively modest at 6.91 to one. Our Portfolio Leverage the GSEs announced programs to available liquidity at year-end totaled Repurchase Arrangements buyout a backlog of seriously over $650 million, which should and Similar Borrowings divided by Long-Term delinquent loans from their guarantee provide ample liquidity to manage our Investment Capital portfolios. This created a period of existing investment portfolio and to sharply higher mortgage prepayments take advantage of opportunities to as delinquent loans were removed acquire additional agency-guaranteed from the GSE securities that we own. ARM securities. As a result, our portfolio runoff On what could have significant (mortgage prepayments and scheduled political and economic implications $7.48 $1.04 billion billion payments) increased to over $2.9 for years to come, in February 2011, billion in 2010, nearly doubling the Department of the Treasury runoff experienced in 2009. After the released the Administration’s plan to delinquency backlog cleared in July, reform America’s housing finance Portfolio Composition mortgage prepayments declined market. We applaud elements of the 88% Current-Reset ARMs considerably allowing for a recovery in plan designed to address fundamental 12% Longer-to-Reset ARMs net interest margins and earnings flaws in the mortgage market by temporarily diminished by high levels improving underwriting standards and of investment premium amortization by phasing in higher down-payment charges and lower portfolio balances requirements. and leverage.
Our recent success in re-leveraging our long-term investment capital, together with the favorable prepay characteristics of our seasoned portfolio of agency-guaranteed ARM securities and continued low borrowing rates, bolsters our expectations that we will continue to produce strong financial results in 2011.
We will continue to be opportunistic in growing our holdings of agency-guaranteed ARM securities and our investment capital, while remaining mindful of the market's recent history in determining the appropriate amount of leverage and liquidity required to prudently manage our portfolio.
[ P.5 ] C a p s t e a d M o r t g a g e C o r p o r a t i o n The Administration’s plan also tightening policy by the FOMC and calls for gradually reducing the GSEs’ that they will first use other tools to footprint in housing finance by achieve their policy objectives before lowering conforming loan limits and resorting to increasing the federal eventually winding down the size of funds rate. Should this prove to be the GSEs’ investment portfolios, the case, our borrowing rates could which together currently total $1.5 remain low throughout 2011. trillion. Our recent success in re- More importantly, the leveraging our long-term investment Administration’s plan puts forth capital, together with the favorable several longer-term reform options prepay characteristics of our seasoned Formed in 1985, Capstead has the for structuring the government’s portfolio of agency-guaranteed ARM distinction of being the oldest residential future role in the housing market. securities and continued low mortgage REIT. Our most recent five- Each of the three options presented borrowing rates, bolsters our year compound annual growth rate of would produce a market where the expectations that we will continue to over 29% is well above our peers. private sector plays the dominant role produce strong financial results in in providing mortgage credit, and 2011. As market conditions evolve, Mortgage Securities and each option has its advantages and we will continue to be opportunistic Similar Investments disadvantages. in growing our holdings of agency- (Millions) While the debate in Washington guaranteed ARM securities and our $8,516 $8,091 $7,499 $7,108 will likely be fierce at times, what investment capital, while remaining cannot be lost in the debate is the mindful of the market's recent $5,252 critical role the GSEs play in history in determining the providing access to home mortgages appropriate amount of leverage and at reasonable rates for creditworthy liquidity required to prudently Americans throughout the economic manage our portfolio. cycle and the liquidity the GSEs We look forward to our next 25 provide to the mortgage market years, and on behalf of our board of Long-Term Investment Capital (Millions) during periods of market disruptions. directors and all of our employees, ■ Unsecured Borrowings, net The Treasury Secretary has thank you for your continued ■ Preferred Stock pledged that the reform process will support and investment. $1,127 $1,114 ■ Common Stock proceed in a responsible and careful $860 $100 manner in order to “support the Sincerely, $179 $661 recovery and the process of repair of $440 the housing market.” We believe any significant changes to the housing finance market will take years to Andrew F. Jacobs $848 develop and, in the end, the President and CEO government will continue to March 1, 2011 Dividends Per Common Share provide a guarantee of conforming mortgage loans. $2.24 Regarding monetary policy, the $2.02 $1.51 Federal Open Market Committee ("FOMC") of the Federal Reserve continues to signal that higher short- term interest rates are not forthcoming $0.34 for some time. We believe the recent $0.08 economic recovery remains too fragile to withstand an aggressive
[ P.6 ] C a p s t e a d M o r t g a g e C o r p o r a t i o n Consolidated Balance Sheets (In thousands, except per share amounts) December 31 2010 2009 Assets: Mortgage securities and similar investments ($8.22 billion and $7.86 billion pledged under repurchase arrangements, respectively) $8,515,691 $8,091,103 Cash collateral receivable from interest rate swap counterparties 35,289 30,485 Interest rate swap agreements at fair value 9,597 1,758 Cash and cash equivalents 359,590 409,623 Receivables and other assets 76,078 92,817 Investments in unconsolidated affiliates 3,117 3,117 $8,999,362 $8,628,903 Liabilities: Repurchase arrangements and similar borrowings $7,792,743 $7,435,256 Cash collateral payable to interest rate swap counterparties 9,024 – Interest rate swap agreements at fair value 16,337 9,218 Unsecured borrowings 103,095 103,095 Common stock dividend payable 27,401 37,432 Accounts payable and accrued expenses 23,337 29,961 7,971,937 7,614,962 Stockholders’ equity: Preferred stock - $0.10 par value; 100,000 shares authorized: $1.60 Cumulative Preferred Stock, Series A, 187 and 188 shares issued and outstanding at December 31, 2010 and December 31, 2009, respectively ($3,073 aggregate liquidation preference) 2,620 2,630 $1.26 Cumulative Convertible Preferred Stock, Series B, 15,819 shares issued and outstanding at December 31, 2010 and December 31, 2009 ($180,023 aggregate liquidation preference) 176,703 176,703 Common stock - $0.01 par value; 250,000 shares authorized: 70,259 and 69,319 shares issued and outstanding at December 31, 2010 and December 31, 2009, respectively 703 693 Paid-in capital 1,028,382 1,017,185 Accumulated deficit (354,883) (356,154) Accumulated other comprehensive income 173,900 172,884 1,027,425 1,013,941 $8,999,362 $8,628,903 Book value per common share (based on common shares outstanding and calculated assuming liquidation preferences for the Series A and B preferred stock) $12.02 $11.99 See the accompanying notes to our consolidated financial statements included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2011, and available on our website at www.capstead.com.
[ P.7 ] C a p s t e a d M o r t g a g e C o r p o r a t i o n Consolidated Statements of Income (In thousands, except per share amounts) Year Ended December 31 2010 2009 2008 Interest income: Mortgage securities and similar investments $199,300 $314,100 $398,285 Other 478 495 2,204 199,778 314,595 400,489 Interest expense: Repurchase arrangements and similar borrowings (47,502) (120,083) (249,706) Unsecured borrowings (8,747) (8,747) (8,747) Other (2) – – (56,251) (128,830) (258,453) 143,527 185,765 142,036 Other revenue (expense): Impairment and related charges associated with investments in commercial real estate loans – (40,423) – Miscellaneous other revenue (expense) (904) (218) (1,593) Incentive compensation expense (5,055) (4,769) (6,000) General and administrative expense (10,931) (11,351) (8,779) (16,890) (56,761) (16,372) Income before equity in earnings of unconsolidated affiliates 126,637 129,004 125,664 Equity in earnings of unconsolidated affiliates 259 259 259 Net income $126,896 $129,263 $125,923 Net income available to common stockholders: Net income $126,896 $129,263 $125,923 Less cash dividends paid on preferred shares (20,233) (20,239) (20,251) $106,663 $109,024 $105,672 Earnings per common share: Basic $1.53 $1.67 $1.94 Diluted 1.52 1.66 1.93 Cash dividends per common share 1.51 2.24 2.02 Average number of common shares outstanding: Basic 69,552 65,045 54,007 Diluted 69,901 65,449 54,468 See the accompanying notes to our consolidated financial statements included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2011, and available on our website at www.capstead.com.
[ P.8 ] C a p s t e a d M o r t g a g e C o r p o r a t i o n Directors Jack Biegler Gary Keiser Christopher W. Mahowald Mark S. Whiting Private Investments Private Investments President, Managing Partner, Chairman of the Board RSF Management and Drawbridge Partners, LLC Paul M. Low RSF Partners Andrew F. Jacobs Private Investments President and Chief Chairman Emeritus Michael G. O’Neil Executive Officer Private Investments Officers President and CEO Executive Vice Presidents Senior Vice Presidents Vice Presidents Andrew F. Jacobs Phillip A. Reinsch Michael W. Brown Diane F. Wilson President and Chief Chief Financial Officer Asset and Liability Financial Accounting Executive Officer and Secretary Management and Treasurer and Reporting Robert R. Spears, Jr. D. Christopher Sieber Richard A. Wolf Director of Residential Financial Accounting Asset and Liability Mortgage Investments and Reporting Management 25th Anniversary Celebrated at NYSE
[ P.9 ] C a p s t e a d M o r t g a g e C o r p o r a t i o n Corporate Shareholder Information Transfer Agent and Registrar Available Information Inquiries concerning dividend payments, lost certificates, Capstead makes available on its website at www.capstead.com, change of address and account information should be free of charge, its annual report on Form 10-K, quarterly directed to: reports on Form 10-Q, current reports on Form 8-K, investor presentations, quarterly fact sheets, press releases, charters for Wells Fargo Shareowner Services the committees of the board of directors, the Board of Post Office Box 64854 Directors Guidelines, the Code of Business Conduct and St. Paul, Minnesota 55164-0854 Ethics, the Financial Code of Professional Conduct and other (800) 468-9716 company information, including amendments to such www.wellsfargo.com/shareownerservices documents and waivers, if any, to the codes. Such information is also furnished upon written request to: Preferred Share Conversions Holders of the Series A and Series B preferred shares may convert Capstead Mortgage Corporation into common shares at any time. Attention: Stockholder Relations 8401 North Central Expressway Holders of the Series A and Series B preferred shares are Suite 800 advised to carefully consider whether or not it is economically Dallas, Texas 75225-4410 advantageous to convert into common shares, considering the conversion ratio as well as the prevailing market prices and Annual Meeting dividends of both the common and preferred shares. The annual meeting of stockholders will be held at 9:00 A.M. central time on Wednesday, May 4, 2011 at: If conversion is requested after one or more preferred record dates and on or before the record date for payment of 8401 North Central Expressway quarterly dividends on the common shares, the preferred Suite 345 holder requesting conversion must return to Capstead all Dallas, Texas 75225-4410 preferred share dividends declared and paid for the corresponding quarter. Total Return Performance* $400 Capstead Mortgage Corporation 350 29.3% CAGR 300 250 200 150 Russell 2000 Index 4.5% CAGR 100 NAREIT Mortgage Index 50 -6.3% CAGR 0 12/05 12/06 12/07 12/08 12/09 12/10 * Total Returns and compound annual growth rates (“CAGR”) are based on the following cumulative total returns assuming the investment of $100 on December 31, 2005 and the reinvestment of dividends. The performance shown is not necessarily indicative of future results. Cumulative Periods Ending December 31, 2005 2006 2007 2008 2009 2010 Capstead Mortgage Corporation $100.00 $144.35 $235.95 $229.63 $344.99 $360.91 Russell 2000 Index 100.00 118.37 116.51 77.15 98.11 124.46 NAREIT Mortgage Index 100.00 119.32 68.79 47.25 58.89 72.20
8401 North Central Expressway Suite 800 Dallas, TX 75225 800.358.2323 www.capstead.com FORWARD-LOOKING STATEMENTS This document contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “project,” “will be,” “will likely continue,” “will likely result,” or words or phrases of similar meaning. These forward-looking statements are based largely on the expectations of management and are subject to a number of risks and uncertainties including, but not limited to, the following: changes in general economic conditions; fluctuations in interest rates and levels of mortgage prepayments; the effectiveness of risk management strategies; the impact of differing levels of leverage employed; liquidity of secondary markets and credit markets; the availability of financing at reasonable levels and terms to support investing on a leveraged basis; the availability of new investment capital; increases in costs and other general competitive factors; deterioration in credit quality and ratings; the availability of suitable qualifying investments from both an investment return and regulatory perspective; the availability of residential mortgage pass-through securities issued and guaranteed by the GSEs, currently Fannie Mae or Freddie Mac, or by an agency of the federal government, currently Ginnie Mae; and changes in legislation or regulation affecting the GSEs and similar federal government agencies and related guarantees. In addition to the above considerations, actual results and liquidity are affected by other risks and uncertainties many of which are set forth in the “Risk Factors” sections contained in the Company’s periodic filings with the SEC, which could cause actual results to be significantly different from those expressed or implied by these forward-looking statements. Any forward-looking statements speak only as of the date the statement is made, and the Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. It is not possible to identify all of the risks, uncertainties and other factors that may affect future results. In light of these risks and uncertainties, the forward-looking events and circumstances discussed herein may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. Accordingly, readers of this document are cautioned not to place undue reliance on the forward-looking statements. 76005