Q4 2020 Capstead Mortgage Corp Earnings Call
Hello, and welcome all of the Capstick word mortgage Corporation fourth quarter 2020 earnings Conference call all participants will be on listen only mode.
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Now, let's turn the conference over to Lindsey Crabbe manager of IR Ms. Crabbe. Please go ahead.
Good morning, Thank you for attending the fourth quarter earnings Conference call.
Fourth quarter earnings versus the free.
Yesterday, great franchises the funnel.
And of course, it on the website at Www SEC.
Is that the com under the Investor interest.
This webcast is also in the Investor Relations section of our on site.
An archive of this webcast and a replay of this call will be available through April of 'twenty 'twenty four.
Details of the replay are included in yesterday's release.
On the call today are Phil Reinsch, President and Chief Executive Officer, Robert Spears, Executive Vice President and Chief Investment Officer, Phillip Senior Vice President and Chief Financial Officer.
Before we get started I want to remind you. The some of today's comments could be considered forward looking statements pursuant to the safe Harbor provisions of the private Securities Litigation Reform Act of 90, 95 and are based on certain assumptions.
In addition, the insurance amusements call of non-GAAP financial measures reconciliations provided in the company's earnings release in the company.
Table or cash.
Which have been filed on form 8-K, with the SEC and May also the access of the company's website for a detailed list of all of the risk factors associated with our business. Please refer to our filings with the SEC, which are available on our website. The information contained on this call. The current only as of the damage from January <unk>.
The company assumes no obligation to update any statements, including any forward looking statements made during the call with that I will turn the call over to Phil.
Thank you Lindsay and thanks to everyone for your interest in cash.
After I make a few brief remarks line. So I'll give a quick recap of the fourth quarter.
Robert is going to provide us with the current market color and then we'll open the call up the question.
We're pleased to report another steady quarter with lower borrowing costs offsetting the effects on the portfolio yields of continued high mortgage prepayments as of <unk>.
Americans continue to take advantage of generational lows in mortgage rates to refinance or purchase of new homes on.
On a core earnings basis, we earned our 15 for income dividend producing 885% annualized return on common equity for all of 2020, we earned 9% by those measures.
We accomplished the returns with lower leverage the portfolio of balances post sandy.
Common dividend itself was unchanged for five quarters, now and our core earnings met or exceeded the dividend in each of these quarters. Despite the market disruption experienced the door.
We are the only mortgage REIT that can make that claim in fact.
Looking at peers in the residential mortgage REIT space on an average of their dividends currently found on about 50% of what they were pre pandemic.
And Thats, a stark contrast of our steady performer.
Our book value is down 4% from the fourth quarter, which together with the 15th common dividend.
Resulted.
And a three months of economic return of one 6%.
Or six 5% on an annualized basis.
Since the pandemic induced fixed income the disruption in March and through year end book value was up 69%.
Which together with 45 and common dividend result of an economic return of about 19% or 25% of annualized thus far in 2021.
Value is little changed.
Any of the 675 of share.
Looking forward, we are optimistic that we'll not see a repeat of the market disruptions experienced in March given the lower leverage levels in the market and the fed bond buying program.
However, mortgage prepayments remain at high levels of no small part due to the fed continued heavy involvement from the markets. This is having the effect of lowering the returns and crowding out of private capital, making it harder to reinvest capital made available from portfolio runoff at attractive levels, we expect prepays the moderate.
Over time as runoff was replaced with slower paying new production with the seasoning of the existing holdings and was lower coupon interest rates on our currently resetting the bar.
Given these market conditions were being judicious in deploying on liquidity building flexibility to potentially take advantage of opportunities as they unfold in the coming quarters with that I'll turn the call over to the lamps and Robert.
We reported a GAAP net income of $43 3 million this quarter or <unk> 19 cents per diluted common share all of our core earnings were $19 7 million or 15 cents per diluted common share.
As a reminder of our core earnings exclude realized and unrealized losses on our portfolio related interest rate swap agreements. We include a reconciliation of our GAAP to core earnings on page nine of our press release.
Book value decreased four cents per share during the fourth quarter ending at $6 76 per common share.
The derivative related increases of 10.
Being offset by 14th and the portfolio related decline largely due to the runoff.
The portfolio portfolio yields averaged 155% during the quarter a decrease of 30 basis points from the 185% we reported in the prior quarter.
Yields declined due to lower coupon interest rates on acquisitions and on existing loans that reset the lower current prevailing interest rates as well as higher yield adjustments for investment premium amortization due to continuing high levels of mortgage prepayments.
Our portfolio related borrowing costs after adjusting for our hedging activities.
43, 7% during the fourth quarter 30 basis points lower than in the prior quarter, leading to approximately a one basis point improvement in our net interest spreads.
As a result of pare out during the quarter at December 31 of the fixed pay rate on our swap book was 41, 4% of decline of 65 basis points from rates in effect on September 30th vs.
The lower fixed rates going forward will benefit future earnings.
Robert.
Yes.
The yield curve steepened.
During the fourth quarter of 10 year yields increasing 43 basis points, while two of your yields declined five basis points long term the strength as a positive for our valuations on our supply.
There was all of our short term disruption and new issue of RMB MBS originations due to the transition from LIBOR the sulfur indexes.
On your originators quit taking lot of where applications early in the quarter, but didnt get set of product rolled out as a result of fourth quarter production of the skew to the downside on the lowest level of the year at roughly $1 billion.
At the same type of an extremely strong bank debt from new issue are all shapes and sizes caused spreads to tighten dramatically on the law.
Lowest coupon newest paper that is perceived in the EMEA from Prepays.
Of the secondary selling was very light in the quarter.
As a result of the crop price currently.
Currently seeing more value in the season of Orange space as opposed to new ish.
Prepayments remained elevated we.
This trend to continue for the next several months.
As we move the 2021 of the yield curve Steepening trend has remained intact.
We're starting to see who suffer arent coming out of the block size forward trades.
As a matter of fact, we've already seen over 201 billion of this new software of paper in January the line.
While spreads are relatively tight on the safer. The fact that supply is starting to come out of a more normalized fashion as positive Nonetheless, I would expect the markets.
Much more normalized as far as production and volume around.
Around the March and with that we'll open the call up the questions.
Yes. Thank you.
Now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.
If youre using a speakerphone please pick up your handset before pressing the keys to withdraw your question. Please press Star then two at this time, we will pause momentarily to assemble the roster.
And the first question today comes from Steve Delaney with JMP Securities.
Hey, good morning, everyone. How are you.
Alright, thanks for the comments and the end of the good release last night the.
Robert you talked about sort of the tightness in the market a lot of that sounds like just supply and demand, but help us get a sense of where as you see the market today.
What give us a range or an idea of what's your minimum ROE hurdle is to invest.
The new cash on them it sounds like you've kind of step back and that minimum hurdle.
Does that.
Change between say current reset and fresh paper longer duration paper.
Yes, sure I mean, I think it is.
Just thinking about it we of preferred preferred out there et cetera and that happens.
At a minimum.
We are not going to.
Invest unless we can get on 8% Levered return and so right now.
We are seeing.
And the leverage anywhere from seven of the quarter at a time.
On the 9% returns at some in some parts of the market, but thats the namely the seed in the space.
With where new production is trading right now.
Size of that book.
Well I would expect.
The spreads the normalized so as production picks up.
The fixed rates of Titan as well so arms stuff is trading of the vacuum the.
Sure of hard right now.
How how long of the bank bid last a lot of times of those guys are in hedging of the first quarter and then they pay back the way. So that's one of the Wildcards, but.
So on the next couple of months I think.
New issue of papers going to say on the fiber side, and we're probably not going to be super active in that space. We're on.
Optimistic as we move through the year, though given the slope of the curve and what we're seeing on already.
Some of the larger originators of played out $25 million to $30 million block size.
Bonds out into the March and April already and so we're very optimistic about debt over the coming months not so much of the in the first month of two of the year because the trades we've seen so far.
The new issue hybrid papers tightened FERC, along with fixed price.
Right now outside of the compelling we think that could change over the next few of US. So we're going to probably in the short run stick more to see the paper.
Got it that's helpful. Thank you and Lance one for you.
Sure.
Kind of expanded disclosure of these days on fair value swap maturities disclosures.
And just looking at your table here for December 31 versus non 30.
You've you've gotten rid of obviously some some much higher cost swaps, but also I think you're you've switched the OIS swaps.
Should I interpret this that when you say you've got on average fixed rate in any particular quarter, let's say third quarter of 2022, and it's the only one basis point is that just your net between what I would normally think of as the fixed pay versus received spread on that swap contract.
Yeah.
No that's actually all of our average fixed pay.
The average pay all of the warrants maturing in that period.
Right, So youre, basically, saying youre paying one basis point.
Yes.
For the so you mean that third quarter example, that swap notional amount of $1 2 billion as of yet.
Fixed the fixed rate of one basis point.
Okay.
Follow up on that the current current to your OIS swaps are at about eight basis points of that one right spend the money right now.
Okay. Thanks, I'm going to do a follow up with you Lance.
So just to just to make sure I'm clear on that for modeling purposes. Thanks for the comments guys.
You bet.
Thank you and the.
The next question comes from Jason Stewart with Jones trading.
Hey, good morning, and congratulations on a great 2020, I think the.
Good kudos for a good performance in the tough year.
<unk> on the yield adjustment in the fourth quarter Lance if you could quantify it if possible and then maybe sort of set expectations for anything.
Anything that would occur again in the first quarter, if that sort of level set.
The numbers there.
Yeah.
So all of arm of the fourth quarter.
Yield adjustments.
One of.
Well we did.
Well, we havent been disclosing the breakdown of that but it's been.
Pretty consistent in the.
Seven basis points.
Yields adjusted mine I don't want to say over the last second half of the year.
For the first quarter.
A.
As a reminder of some of our peers of the job.
Adjusted life speeds on a pretty regular basis and then they backed it out of core earnings. We traditionally do that on an annual basis and looked at lot of speeds. The there's no requirement for that but that's how we kind of trying to look a little more longer term.
We've done that in the past over the last.
A couple of years of at least in the first quarter and I would expect that's what we're going to look at it again this year.
With the higher prepayments obviously.
There's a chance we would move those speeds.
And if we do we would certainly disclose the impact or kind of the.
What others call of the catch up but from what we would just say the lightspeed adjustment, we would disclose that in the.
First quarter from break that out for you.
Okay. Thanks, and then.
Obviously, we've seen a little bit of a whipsaw on rates in the first quarter. So far if you wouldn't mind, just walking us through a little bit of how the portfolio has performed in terms of duration extension and.
I appreciate the comments on new issue.
But just from the way that the of the legacy of his traded so far given.
The short duration nature of it and what we've seen happen in rates of the things that would be helpful.
Sure.
Yeah.
As Phil mentioned on our book value was down on any of our glass.
Mark which was as of.
Closing the business Mark as of close of business last Friday, and so essentially if you look at the curve.
Two to three year part of the curve is pretty much unchanged.
<unk>.
Given the duration of our book.
It really hasn't moved a lot all of the spread on newer issue lower coupon paper at time, So we've seen some of those prices on the.
The lowest coupon on paper, we have an improved by as much as of quarter of a point most of the other paper is.
Comparable paper out there is fairly flat and so.
Not not of lot of moving the so far to catheter on the market in general what's going on right now.
Most of newer paper is trading somewhere between one of the fourth quarter on.
The quarter and Theres, a lot of price compression stuff I can see on fixed rate because it is kind of the speed play right now so in this environment.
Just like the fixed rate market the better performing paper right now is either lower coupon of four.
The various season with the <unk>.
Really good speed of store.
Is that does that answer your question.
Yeah, that's super helpful. I, just think that with the the context in terms of portfolio of performance and the moving longer term rates helpful debt.
The stratify the way that the portfolio's performance. So that's helpful. Thank you.
Sure.
Thank you and the next question comes from John I've worked with the G capital.
Yes, I was just curious can you talk a little bit about on I'm sure you're you're frustrated by the valuation and your stock relative to you guys being the only mortgage REIT that didn't cut the dividend at the et cetera, you're trading about 81% of book.
Since you are bringing down leverage.
Do you look to potentially start to.
Deploy some of that capital and buy the stock back down here at these levels.
Yes, that's a great question.
We are trading.
And at a lower multiple than we think we deserve obviously.
Considering the 100% agency book.
And and we have performed well from a cash flow perspective.
The.
With the leverage coming down all of it in the fourth quarter with the supply and demand dynamics that have been in place that Robert described.
We'll see how that plays out but we.
We would probably run down run leverage potentially even lower by the end of the first quarter. If we don't see good opportunities to deploy capital. So that that gives us a lot of flexibility to look at the.
To look at buybacks or other maneuvers.
Use the capital. So so we are certainly.
Open to doing what's best for our stockholders in that regard.
Okay and then the other question that I have for you is it.
Aegean Sea on their call I know your book of different et cetera, but they were talking about how they think theres potentially getting to some kind of burn out on re size any of that we're getting closer to that et cetera can you give us any insights on just kind of what you see in refis relative to the on market.
Sure I mean I think.
Over time, most segments of the MBS market start to exit the burnout and arms are not different in that regard I would think that.
Prepayments will remain elevated throughout most of this year and then after that.
At the point, where pretty much already out there.
As of refi Ed so.
The dynamics right now the others.
Over the next six to nine months look like speeds or go to the elevated and I think after that.
You should start to see some burnout exhibited and also the difference too.
Our book versus the fixed rates low yeah are.
Our shorter reset securities that are resetting lower and yield.
Fully indexed arm on the seasoned short reset paper.
The borrower now is around two 5% and so those loans the reset downward.
They will they will slow down as well.
And that's not necessarily the burn out, but the nice feature of our portfolio of the.
Cohorts that are to remain low.
On the fast would probably be the different than you'd think about fixed rates in terms of <unk>.
Coupons that we have three on hire for instance.
0.2 remained fast firm for a while but all in all.
After we get through the first.
Six to nine months of this year, we think of everything that we can see.
The start of moderate.
Okay.
Yes, I'll go ahead I'm, sorry, we're just real quick aside to Robert's point about our current resetting of the portfolio. We had the request to increase our disclosure relative to out of those bonds will reset in the coming year or so so we added a sentence to that effect.
On the last page of the the.
The press release.
And it's 36% right.
Just wondering on exports.
Yes, there is 36% that are going on on average reset in the six months of time, but.
We improve the disclosure to indicate the 22% of that amount.
Will that reset will occur in the next quarter.
The 33% in the.
Second in the quarter after that which would be the third quarter and then.
The remaining 40% over the following six months. So we gave some additional disclosure there.
And we as investors that we should just think about that has positive ramifications as obviously the reset the yield will come down, but there won't be runoff because most likely it's not going to refi correct.
Yes of those folks will have a whole lot less incentive to refinance after their coupons have reset down.
Of course of the portfolio already and slightly slower than the than the bonds. Robert was referring to the have a fixed coupon with the.
Years ago.
Cause they already know or they should know that theyre going to get something out of the coupon reset without having to do anything about it. They don't just happen. So so they won't necessarily refinance of anticipation of the lower coupon on the bonds.
But certainly the app.
Formation of that when the mortgage when it goes down.
Got it correctly the update.
The without getting into the math.
A for instance of five CPR drop in speeds on the seasoned bonds.
They throw off a higher yield.
At the lower coupons.
But it doesn't have the speeds are very.
Very levered on that kind of paper and so.
All in all of it.
The speed decline was more than offset the debt.
But of the coupon on loss.
Got it and then if I could just ask you kind of the bigger picture I mean, obviously, we've seen the steepening significantly into the tens, which eventually should have positive ramifications for your portfolio can you just talk a little bit about kind of what we need to see maybe on fixed rate mortgages before.
Arms really start to maybe explode from a production standpoint, you talked about what was going on in LIBOR versus Sofia, and that's kind of a mechanical issue, but I guess, just what are we rooting for.
To happen.
Well I mean already with the steepness that we've seen originators are out there with the say seven one of arms of it.
As much as three eggs.
The rate difference cheaper the 30 year fixed and from what we're hearing from guys that are in contact with the big originators are seeing that.
They can pick up.
On a production versus the fourth quarter, albeit from a very low level and so that steepness of Wildwood is causing an increase of any speakers from there.
Without the increase supply.
Quiddity in attractiveness I think of the arm market. So we're optimistic about supply going forward.
On the environment right now exceeds further it only gets better.
Okay. Thank you so much for answering my question I really appreciate it and I hope you buy some of the stock back.
Thank you.
And the next question comes from Derek Hewett with Bank of America.
Good morning, everyone.
On a given those near term headwinds on on new issue yields and the portfolio trending modestly lower in <unk>.
Zero.
Lower leverage if.
If you don't buyback any stock at least in the near term how should we think about the sustainability of of the current dividend.
Are these near term or are these headwinds kind of in the near term and things start to normalize in kind of Q2 and beyond.
Or.
What are what are the expectations around those trends.
But theres a lot of moving parts right and a whole lot of optionality in where we could be from a.
From a earnings perspective.
Quarters down the road.
A lot of its kind of depend on what we were just talking about the how how much the yield curve steepens if any.
And and.
And if we can buy bonds of decent ROE, whether we maintain leverage at the levels. We're at.
If we don't what do we do with the capital do we keep it as dry powder do we deploy it.
Yes.
Through buying back our own capital or otherwise.
So there's a lot of unknowns.
This year, it's probably more.
It's more uncertain in terms of some of those factors when you might ordinarily hit out of this say.
So yes.
We're not really prepared to say a whole lot of about where that goes but the.
But we will.
Strive to hold on to our dividend level.
And particularly if it looks to be a T.
Temporary.
Decline in core earnings flow.
Well, we don't want to disrupt the E.
Our pattern of dividends for something in the transitory.
Okay, great. Thank you.
Thank you.
Once again, please press Star then one if you would like to asking the question.
Yes.
The next question comes from Eric Hagen with <unk>.
Hey, Thanks, good morning, guys.
A follow up on on on originators Rolling out so for arms can you just.
Shed some light on the product itself what are the margins on taps in Florida as being offered the borrowers.
Sure so far.
Most of what's come out of bid in the set of one space.
And the difference is the <unk>.
Seven one of the LIBOR had margins of the net margins of plus 160 years of.
The newer so for paper that's come out of that margins of around 212.
It's a theoretically.
Five one <unk> cash structure, if you will because the resets of flight. So it could go it could reset up 5% in the first reset and then one 1% every six months after that and so if you kind of look at how it's trading so far it's really not trading materially different then.
But a lot of are similar to LIBOR of arm of trading is basically trading off the coupon with people assuming the margin adjustment of roughly 50 plus basis points over time.
As the sulfur index as.
Fair adjustment.
Great. That's really interesting color. Thank you hope you guys are well.
Sure. Thanks.
Thank you.
And as that was the last question I would like to return the Florida Lindsey Crabbe for any closing comments.
Thanks again for joining us today, if you have further questions. Please give us we look forward to speaking with you next quarter.
Thank you. This concludes the question and answer session on this as well as the call. Thank you for attending today's presentation. You may now disconnect your lines.
Okay.