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Subject: CMO: Capstead Mortgage Q4 CC Transcripts Date: 2/11/2008 5:22 PM
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http://seekingalpha.com/article/64106-capstead-mortgage-corp-q4-2007-earnings-call-transcript

Andy Jacobs

Thank you, Bethany. Well, the fourth quarter was a much better quarter from where we were in the third quarter of 2007, pretty much as expected. For the year, I think as everybody knows, being an agency securities REIT as we are, 99% of our portfolio is in Fannie, Freddie, Ginnie mortgage-backed securities. At the end of the year our portfolio was about $7.1 billion.

If you go to slide 4, and just a little definition here, the current-reset security and the longer-to-reset securities that you're seeing on this particular page, our portfolio, we invested in just eight loans. These are loans that are going to reset annually, or after a fixed period of five years or less. And, if the current-reset securities that we have are going to be reset over the next 18 months, we will be fine with the current-resets. If it is over 18 months, it will be longer to reset.

I think, looking at this particular page, the key features here are, up to a blend of about 50% of our portfolio comprising the longer-to-reset securities today. That's up from about 35% at the end of the third quarter. And the reason why we are up at this level is. as people here know. We did have the opportunity to enter the capital market a couple of times here in the fourth quarter. Most of the proceeds from those offerings were in the longer-to-reset securities, and so about 70% on a blend of the new capital we got in the fourth quarter went into the longer-reset securities, which moved the mix up to the 50-50 level.

The way we finance this portfolio is one of the key things that you need to understand. The current-reset security is financed with 30 day borrowings, and those are going to be borrowings that adjust within the next 30 days. So that portfolio will benefit from further rate cuts accordingly.

The longer-to-reset securities are financed with a combination of longer dated repo, and a portion of 30 day repo. But on the 30 day repo, we will enter into swap agreements today, to help mitigate the interest rate risk so that they function fairly, much like the longer dated repo.

On a net-net basis, what we continue to try to do is to manage the duration, the net durations, and perhaps that the liability tends to keep it between three to six months. I think currently, we have some in the five month level. It helps to understand that if the Fed is going to continue to lower interest rates, the current reset portfolio that has not been funded with 30-day paper will continue to benefit from that, and a portion of a longer-to-reset securities will continue to benefit from reductions in the Fed funds rate.

With that I'll turn it over to Phil.

Phil Reinsch

Thanks, Andy. If you turn to page 5 of the webcast, we've highlighted for you some of the key takeaways from our fourth quarter financial performance.

Our net interest margins on operating earnings increased significantly quarter-over-quarter, as our financing spread more than doubled to 93 basis points, and we grew our portfolio by $2.3 billion to about $7.1 billion at year end. Financing spreads benefited in a large part, from lower borrowing rates, with the Fed reducing its Fed fund target rates beginning in mid-September, by 100 basis points through the end of the year.

With these rate cuts, and despite some liquidity issues still impacting our market through year end, our borrowing rates declined on average, 38 basis points quarter-over-quarter, with the full benefit of the rate cuts still to come in the first quarter of 2008.

Yields increased to a more modest 13 basis points quarter-over-quarter, due to several factors, including favorable mortgage prepayment, some of our bonds still pricing up in yields, higher yields on acquisitions, particularly early in the quarter, and the sale in the third quarter of faster-prepaying lower-yielding bonds in connection with reducing our balance sheet leverage from about 11.5 times to 10 times.

Portfolio runoff rose significantly during the fourth quarter with an annualized rate of 24%. This reflects seasonal factors, but also national trends toward declining housing values, and tighter mortgage loan underwriting standards.

The growth in our portfolio reflects investing the proceeds from equity offerings during the fourth quarter as Andy alluded to. We raised $199 million in our October and November follow-on public offerings. Another $7 million was raised primarily in December, through our continuous offerings program. These offerings added a $1.11 to common share to our year-end book value, which increased the $1.68 during the quarter to $9.25. The rest of the increase in book value was primarily the result of higher pricing on our residential mortgage securities portfolio at year-end.

Subsequently at year-end we closed on another follow-on offering of 8 million shares at $15.50 per share on February 1st, and just this past Friday we closed on another 600,000 shares, representing one-half of the greenshoe from this offering. Together, after underwriting fees and expenses, this offering provided us with an additional $127 million in common equity capital.

Of course, you are all aware that Fed has cut rates, another 125 basis points in January, and could cut rates further in the coming months. To jump to the cumulative effect on our borrowing cost; from the 225 basis points in rate cuts thus far, we are anticipating a significant increase in our financing spreads in the first quarter, on a substantially larger portfolio. We'll get more into that later in the call.

If you turn to slide 6, our comparative income statement, I wanted to mention a couple of items. We did realize a $593,000 gain during the fourth quarter, from selling about a half of our small non-agency security portfolio, and from the sale back to Fannie Mae of one of their bonds at their request. We currently do not anticipate further asset sales in the coming quarters of any significant amount.

Other revenue during the fourth quarter was relatively high, reflecting high overnight investment balances, due in part to the fourth quarter capital raises, and some other small non-recurring items.

Turning to slide 7, our comparative balance sheet, a couple of items are worth mentioning. As Andy mentioned earlier, the portfolio additions during the fourth quarter allowed our portfolio to migrate to roughly 50/50 mix of current reset, and longer to reset ARM securities by yearend. Robert will provide some additional color on that a little later in the presentation.

Also, I want to point out that the first quarter, it looks as if we made some commercial loan investments, but what actually happened, and it's described in the footnote on this page, we purchased our joint venture partner’s 25% interest in the Redtail Capital joint venture that was previously reflected as an unconsolidated affiliate. Now, the JV sold loan, which is in runoff, is included in the gross on our balance sheet with the rest of our investment, and in some related financing, is included with our borrowings.

Turning to slide 8, this slide graphically depicts our long-term investment capital. Our long-term investment capital consists of $100 million of trust-preferred securities that are actually reflected as unsecured borrowings on our balance sheet. And $180 million of perpetual preferred equity and our common equity capital.

The trust preferred and perpetual preferred capital cost us roughly 10.3%, and provides us significant amount of leverage on our common equity that is very beneficial in the current interest-rate environment. And returns on our ARM securities portfolio are significantly north to the cost of preferred capital. This additional common equity leverages is an important differentiating point in comparing Capstead capital structure to those of our peers.

In the fourth quarter, with fourth quarter capital raises and improvements in the value of our portfolio, our investment capital increased, quarter-over-quarter by $231 million to $661 million by year-end. And after adjusting for these latest offerings that we just closed, our capital increased on pro forma basis, to $788 million today before consideration of other changes in portfolio valuation sequent to year-end.

Overtime, we may leverage our long-term investment capital anywhere from 8 to 12 times, depending upon a variety of factors. Although as you recall, we took our leverage down to about 10 times during the market disruption of the third quarter, and after deploying the fourth quarter capital raises, we ended the year at just over 9.8 to 1 leverage. We expect to maintain our leverage at approximately 10 to 1 in coming quarters, although we will temporarily lower as we deploy the recently raised capital.

Now I'll turn the discussion over to Robert.

(snip)
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