CAPSTEAD MORTGAGE : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL (form 10-Q)

August 04, 2020 at 04:27 pm EDT

CONDITION AND RESULTS OF OPERATIONS


                              FINANCIAL CONDITION

Overview



Capstead operates as a self-managed REIT earning income from investing in a
leveraged portfolio of residential mortgage pass-through securities consisting
almost exclusively of short-duration ARM Agency Securities, which reset to more
current interest rates within a relatively short period of time and are
considered to have limited, if any, credit risk. See NOTE 1 to the consolidated
financial statements (included under Item 1 of this report) for defined terms
used in this discussion and analysis. By investing in short-duration ARM Agency
Securities, the Company is positioned to benefit from future recoveries in
financing spreads and experience smaller fluctuations in portfolio values
compared to leveraged portfolios containing a significant amount of
longer-duration fixed-rate mortgage securities. Duration is a common measure of
market price sensitivity to interest rate movements. A shorter duration
generally indicates less interest rate risk.



Capstead reported for GAAP purposes net income of $23 million and a net loss of
$182 million, representing $0.19 and $(2.01) per diluted common share for the
quarter and six months ended June 30, 2020, respectively. The Company reported
core earnings of $22 million and $42 million, respectively, or $0.18 and $0.34
per diluted common share for the quarter and six months ended June 30, 2020. See
"Reconciliation of GAAP and non-GAAP Financial Measures" for more information on
core earnings. The GAAP loss for the six months ended June 30, 2020 includes
$163 million in losses on hedging-related derivatives due primarily to declining
interest rates and $68 million in losses on the sale of $2.60 billion (basis) in
ARM securities late in the first quarter. These sales, together with not
replacing portfolio runoff in March and April helped ensure the Company had
sufficient flexibility to meet future projected liquidity requirements while
maintaining portfolio leverage at comfortable levels given disruptions
experienced in the fixed income markets brought on by the novel coronavirus
("COVID-19") pandemic. The Company resumed replacing runoff in late April. GAAP
and core earnings benefited from lower secured borrowings rates primarily due to
a total of 150 basis points in reductions in the Fed Funds rate in March and
favorable terms on new interest rate swap agreements entered into during the
first six months of the year. These benefits more than offset lower portfolio
yields due to lower coupon interest rates on loans underlying the Company's ARM
Agency Securities as well as changes in lifetime prepayment estimates.



Capstead finances its residential mortgage investments by leveraging its
long-term investment capital with secured borrowings consisting primarily of
borrowings under repurchase arrangements with commercial banks and other
financial institutions. Long-term investment capital declined $161 million
during the first half of 2020 to $1.01 billion at June 30, 2020, consisting of
$662 million of common and $251 million of preferred stockholders' equity
(recorded amounts), together with $98 million of unsecured borrowings maturing
in 2035 and 2036.



Capstead's residential mortgage portfolio decreased $2.89 billion during the
first half of 2020 to $8.33 billion at June 30, 2020. Secured borrowings
decreased $2.7 billion to $7.58 billion as a result of lower portfolio
balances. Portfolio leverage (secured borrowings divided by long-term investment
capital) decreased to 7.49 to one at June 30, 2020 from 8.77 to one at
December 31, 2019. Management continuously evaluates portfolio leverage levels
in light of changes in market conditions.



                                      -21-

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COVID-19



An unprecedented, near-total shutdown of the U.S. economy beginning in March due
to the COVID-19 pandemic heightened fears of extremely high credit default
levels and recession, leading to de-risking occurring at all levels of the fixed
income markets. Credit asset pricing came under severe pressure destabilizing
fixed income markets and leading to lender margin calls, feeding additional
selling as levered and even unlevered investors across the spectrum were forced
to sell their most liquid positions to raise cash to meet additional margin
calls and/or fund redemptions. Investors were already coming under stress due to
declining Treasury rates which led to losses on derivatives held for hedging
purposes and variation (valuation-based) margin calls.  As the crisis deepened
this additional drain on liquidity became more pronounced and included increased
initial (base haircut) margin requirements due to heightened market volatility.
The result at the end of March was sharply falling asset prices even as market
interest rates declined.  During this period of extreme volatility, Capstead met
all of its funding requirements and maintained sufficient flexibility to meet
its liquidity requirements.



Intervention by the Federal Reserve in the form of the buying of fixed-rate
Agency Securities since late March helped stabilize this key market sector
leading to improved pricing levels for fixed-rate Agency Securities through the
second quarter.  While the Federal Reserve has not purchased ARM Agency
Securities specifically, these actions also contributed to a more stable
operating environment for Capstead, leading to improved pricing levels for ARM
Agency Securities.

The Company's potential liquidity at June 30, 2020 was $500 million and it believes it has ample access to necessary financing through its existing lending counterparties to meet its liquidity needs. See "Utilization of Long-term Investment Capital and Potential Liquidity" for further discussion.





The Company continues to operate portions of its business continuity plan and
has not experienced any operational disruption due to its small number of
employees who are all able to work remotely. Management will continue to closely
monitor the situation and adapt its response as necessary to ensure there are no
operational disruptions.

Recent Common Equity Issuances



During February 2020, Capstead issued 1.6 million shares of common stock through
an at-the-market continuous offering program at an average issue price of $8.21,
net of fees and other costs, for net proceeds of $12.9 million. Additional
amounts of equity capital may be raised in the future under continuous offering
programs or by other means, subject to market conditions, compliance with
federal securities laws and blackout periods.

Book Value per Common Share



Book value per share (total stockholders' equity, less liquidation preferences
for outstanding shares of preferred stock, divided by outstanding shares of
common stock) as of June 30, 2020 was $6.79 per share, an increase of $0.72 per
share or 11.8% from March 31, 2020 book value of $6.07 per share, primarily
reflecting $0.67 per share in portfolio-related increases in value. Book value
declined $1.83 from December 31, 2019 of $8.62 primarily due to
derivative-related declines in value.

All but $1 million of Capstead's residential mortgage investments portfolio and
all of its derivatives are recorded at fair value on the Company's balance sheet
and are therefore included in the calculation of book value per common share.
None of the Company's borrowings are recorded at fair value. See NOTE 9 to the
consolidated financial statements (included under Item 1 of this report) for
additional disclosures regarding fair values of financial instruments held or
issued by the Company.



                                      -22-


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Fair value is impacted by market conditions, including changes in interest
rates, and the availability of financing at reasonable rates and leverage
levels, among other factors. The Company's investment strategy attempts to
mitigate these risks by focusing on investments in Agency Securities, which are
considered to have little, if any, credit risk and are collateralized by ARM
loans with interest rates that reset periodically to more current levels,
generally within five years. Because of these characteristics, the fair value of
the Company's portfolio is considerably less vulnerable to significant pricing
declines caused by credit concerns or rising interest rates compared to
leveraged portfolios containing a significant amount of non-agency securities or
longer-duration ARM and/or fixed-rate Agency Securities.

Residential Mortgage Investments



The following table illustrates Capstead's portfolio of residential mortgage
investments for the quarter and six months ended June 30, 2020 (dollars in
thousands):

                                                    Quarter Ended       Six Months Ended
                                                    June 30, 2020        June 30, 2020
Residential mortgage investments, beginning of
period                                             $     8,503,171     $

11,222,182


Portfolio acquisitions (principal amount)                  614,366

1,408,593


Investment premiums on acquisitions                         24,249

44,569


Portfolio runoff (principal amount)                       (844,722 )           (1,756,821 )
Sales of investments (basis) (a)                           (19,440 )           (2,620,297 )
Investment premium amortization                            (15,388 )              (36,079 )
Increase in net unrealized gains on securities
  classified as available-for-sale                          65,664

65,753


Residential mortgage investments, end of
period                                             $     8,327,900     $

8,327,900


Decrease in residential mortgage investments
during the
  indicated periods                                $      (175,271 )   $       (2,894,282 )

(a) Portfolio sales that settled during the second quarter of 2020 were entered

into during the first quarter and all realized losses associated with these

sales were recognized during the first quarter.




Capstead's investment strategy focuses on managing a portfolio of residential
mortgage investments consisting almost exclusively of ARM Agency
Securities. Agency Securities are considered to have limited, if any, credit
risk because the timely payment of principal and interest is guaranteed by
Fannie Mae and Freddie Mac, which are federally chartered corporations, or
Ginnie Mae, which is an agency of the federal government. Federal government
support for Fannie Mae and Freddie Mac has largely alleviated market concerns
regarding the ability of Fannie Mae and Freddie Mac to fulfill their guarantee
obligations.

By focusing on investing in short-duration ARM Agency Securities, changes in
fair value caused by changes in interest rates are typically relatively modest
compared to changes in fair value of longer-duration ARM or fixed-rate assets.
This investment strategy positions the Company to benefit from potential
recoveries in financing spreads.

Capstead classifies its ARM securities based on the average length of time until
the loans underlying each security reset to more current rates
("months-to-roll") (less than 18 months for "current-reset" ARM securities, and
18 months or greater for "longer-to-reset" ARM securities). The Company's ARM
holdings featured the following characteristics at June 30, 2020 (dollars in
thousands):

                                      -23-


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                                                            Fully      Average     Average    Average    Months
                                  Amortized        Net     Indexed       Net       Periodic   Lifetime     To
          ARM Type              Cost Basis (a)   WAC (b)   WAC (b)   Margins (b)   Caps (b)   Caps (b)    Roll
Current-reset ARMs:
Fannie Mae Agency Securities  $      2,333,856      3.21 %    2.21 %        1.65 %     2.80 %     6.18 %    5.9
Freddie Mac Agency Securities          756,755      3.26      2.24          1.76       2.28       5.51      7.5
Ginnie Mae Agency Securities           164,807      3.32      1.69          1.52       1.12       5.53      4.9
Residential mortgage loans                 436      4.17      4.69          2.09       1.76      11.25      6.1
(40% of total)                       3,255,854      3.23      2.19          1.67       2.59       5.99      6.2
Longer-to-reset ARMs:
Fannie Mae Agency Securities         2,769,701      3.05      2.14          1.60       4.09       5.02     52.0
Freddie Mac Agency Securities        1,563,055      3.00      2.21          1.66       4.21       5.03     60.0
Ginnie Mae Agency Securities           627,253      3.68      1.66          1.50       1.00       5.00     43.9
(60% of total)                       4,960,009      3.12      2.10          1.61       3.74       5.02     53.5
                              $      8,215,863      3.16      2.14          1.63       3.29       5.40     34.8
Gross WAC (rate paid by
  borrowers) (c)                                    3.79

(a) Amortized cost basis represents the Company's investment (unpaid principal

balance plus unamortized investment premiums) before unrealized gains and

losses. At June 30, 2020, the ratio of amortized cost basis to unpaid

principal balance for the Company's ARM holdings was 103.07. This table

excludes $1 million in fixed-rate agency-guaranteed mortgage pass-through

securities, residential mortgage loans and private residential mortgage

pass-through securities held as collateral for structured financings.

(b) Net WAC, or weighted average coupon, is the weighted average interest rate of

the mortgage loans underlying the indicated investments, net of servicing and

other fees as of the indicated date. Net WAC is expressed as a percentage

calculated on an annualized basis on the unpaid principal balances of the

mortgage loans underlying these investments. As such, it is similar to the

cash yield on the portfolio which is calculated using amortized cost

basis. Fully indexed WAC represents the weighted average coupon upon one or

more resets using interest rate indexes and net margins as of the indicated

date. Average net margins represent the weighted average levels over the

underlying indexes that the portfolio can adjust to upon reset, usually

subject to initial, periodic and/or lifetime caps on the amount of such

adjustments during any single interest rate adjustment period and over the

contractual term of the underlying loans.

typically have either 200 or 500 basis point initial caps (and floors) with

200 basis point periodic caps (and floors). Additionally, certain ARM

securities held by the Company are subject only to lifetime caps or are not

subject to a cap. Nearly all ARM securities held by the Company have lifetime

floors equal to their net margins. For presentation purposes, average

periodic caps in the table above reflect initial caps until after an ARM

security has reached its initial reset date and lifetime caps, less the

current net WAC, for ARM securities subject only to lifetime caps. At

quarter-end, 67% of current-reset ARMs were subject to periodic caps

averaging 1.90%; 24% were subject to initial caps averaging 2.97%; and 8%

were subject to lifetime caps averaging 7.01%.. All longer-to-reset ARM

securities at June 30, 2020 were subject to initial caps.

(d) Gross WAC is the weighted average interest rate of the mortgage loans

underlying the indicated investments, including servicing and other fees paid

by borrowers, as of the indicated balance sheet date.




Approximately 24%, or $763 million of the Company's current-reset ARM securities
with average net WACs of 2.70% and fully-indexed WACs of 2.16% will reset in
rate for the first time in less than 18 months based on indices in effect at
June 30, 2020. After consideration of any applicable initial fixed-rate periods,
at June 30, 2020 approximately 90%, 5% and 3% of the Company's ARM securities
were backed by mortgage loans that reset annually, semi-annually and monthly,
respectively, while approximately 2% reset every five years. Approximately 3% of
the Company's ARM securities were backed by interest-only loans, with remaining
interest-only payment periods averaging 14 months at June 30, 2020. All
percentages are based on averages of the characteristics of mortgage loans
underlying each security and calculated using unpaid principal balances as of
the indicated date.

                                      -24-


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Secured Borrowings and Related Derivatives Held for Hedging Purposes



Capstead has traditionally financed its residential mortgage investments by
leveraging its long-term investment capital with secured borrowings consisting
primarily of borrowings under repurchase arrangements with commercial banks and
other financial institutions that involve the sale and a simultaneous agreement
to repurchase the transferred assets at a future date and are accounted for as
financings. The Company maintains the beneficial interest in the specific
securities pledged during the term of each repurchase arrangement and receives
the related principal and interest payments.



The terms and conditions of secured borrowings are negotiated on a
transaction-by-transaction basis when each such borrowing is initiated or
renewed. None of the Company's counterparties are obligated to renew or
otherwise enter into new borrowings at the conclusion of existing borrowings.
Collateral requirements in excess of amounts borrowed (referred to as
"haircuts") averaged 4.50 percent of the fair value of pledged residential
mortgage pass-through securities at June 30, 2020, relatively consistent with
prior year. After considering haircuts and related interest receivable on the
collateral, as well as interest payable on these borrowings, the Company had
$413 million of capital at risk with its lending counterparties at June 30,
2020. The Company did not have capital at risk with any single counterparty
exceeding 6% of total stockholders' equity at June 30, 2020.

Secured borrowing rates are generally fixed based on prevailing rates
corresponding to the terms of the borrowings. Interest may be paid monthly or at
the termination of a borrowing at which time the Company may enter into a new
borrowing at prevailing haircuts and rates with the same counterparty or repay
that counterparty and negotiate financing with a different counterparty. When
the fair value of pledged securities declines due to changes in market
conditions or the publishing of monthly security pay-down factors, lenders
typically require the Company to post additional securities as collateral, pay
down borrowings or fund cash margin accounts with the counterparties in order to
re-establish the agreed-upon collateral requirements, referred to as margin
calls. Conversely, if collateral fair values increase, lenders are required to
release collateral back to the Company pursuant to Company-issued margin calls.



As of June 30, 2020, the Company's secured borrowings totaled $7.58 billion with
19 counterparties at average rates of 0.25%, before the effects of
currently-paying interest rate swap agreements. The Company typically uses
interest rate swap agreements with terms between 18 and 36 months and variable
rate receipts based on three-month LIBOR or Fed Funds to help mitigate exposure
to rising short-term interest rates. During the first half of 2020, the Company
decreased its swap positions by $2.80 billion notional amount. At quarter-end
the Company held $4.60 billion notional amount of these derivatives at fixed
rates averaging 1.27% with contract expirations occurring at various dates
through the second quarter of 2022 and a weighted average expiration of
15 months.



Including the effects of these derivatives, the Company's residential mortgage
investments and secured borrowings had estimated durations at June 30, 2020 of
14 months and nine months, respectively for a net duration gap of approximately
five months - see "Interest Rate Risk" for further information about the
Company's sensitivity to changes in market interest rates. The Company intends
to continue to manage interest rate risk associated with holding and financing
its residential mortgage investments by utilizing suitable derivatives such as
interest rate swap agreements, Eurodollar futures and longer-maturity secured
borrowings, if available at attractive rates and terms.



                                      -25-

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Utilization of Long-term Investment Capital and Potential Liquidity



Capstead's investment strategy involves managing an appropriately leveraged
portfolio of ARM Agency Securities that management believes can produce
attractive risk-adjusted returns over the long term, while reducing, but not
eliminating, sensitivity to changes in interest rates. The potential liquidity
inherent in the Company's unencumbered residential mortgage investments is as
important as the actual level of cash and cash equivalents carried on the
balance sheet because secured borrowings generally can be increased or decreased
on a daily basis to meet cash flow requirements and otherwise manage capital
resources efficiently. Potential liquidity is affected by, among other factors:

• current portfolio leverage levels,

• changes in market value of assets pledged and derivatives held for hedging


        purposes as determined by lending and swap counterparties,


  • mortgage prepayment levels,


  • collateral requirements of lending and derivative counterparties, and

• general conditions in the commercial banking and mortgage finance industries.

Capstead's utilization of its long-term investment capital and its estimated potential liquidity were as follows as of June 30, 2020 in comparison with December 31, 2019 (dollars in thousands):



                                                                 Secured

Capital Potential Portfolio


                                          Investments (a)       Borrowings       Employed        Liquidity (b)      Leverage
Residential mortgage investments         $       8,327,900     $  7,575,294     $   752,606     $       377,575
Cash collateral receivable from
  derivative counterparties, net (c)                                                 54,043                   -
Other assets, net of other liabilities                                              204,683             121,991
Balances as of June 30, 2020:            $       8,327,900     $  7,575,294

$ 1,011,332 $ 499,566 7.49:1

Balances as of December 31, 2019 $ 11,222,182 $ 10,275,413

$ 1,172,125     $       537,134        8.77:1

(a) Investments are stated at balance sheet carrying amounts, which generally

reflect estimated fair value as of the indicated dates.

(b) Potential liquidity is based on maximum amounts of borrowings available under

existing uncommitted financing arrangements considering management's estimate

of the fair value of residential mortgage investments held as of the

indicated dates adjusted for other sources of liquidity such as cash and cash

equivalents and cash collateral pledged to secured borrowing counterparties.

cash collateral payable to derivative counterparties, if applicable, and the

fair value of interest rate swap positions as of the indicated date.




In order to efficiently manage its liquidity and capital resources, Capstead
attempts to maintain sufficient liquidity reserves to fund borrowing and
derivative margin calls under stressed market conditions, including margin calls
resulting from monthly principal payments (remitted to the Company 20 to 45 days
after any given month-end), as well as reasonably possible declines in the
market value of pledged assets and derivative positions. Should market
conditions deteriorate, management may reduce portfolio leverage and increase
liquidity by raising new equity capital, selling mortgage securities and/or
curtailing the replacement of portfolio runoff. Additionally, the Company
routinely does business with a large number of lending counterparties, which
bolsters financial flexibility to address challenging market conditions and
limits exposure to any individual counterparty.



The Company's leverage ratio of 7.49:1 at June 30, 2020 is the result of
improved valuations of its existing portfolio, coupled with not fully replacing
second quarter portfolio runoff. In light of the volatility experienced in the
first quarter, the Company began reinvesting portfolio runoff in late April at
attractive levels, replacing all of May and June runoff. The Company expects in
the near-term for leverage to remain at or near these levels given current
market conditions. Future levels of portfolio leverage will be dependent

                                      -26-

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on many factors, including the size and composition of the Company's investment portfolio (see "Liquidity and Capital Resources").

Reconciliation of GAAP and non-GAAP Financial Measures



Management believes the presentation of core earnings and core earnings per
common share, both non-GAAP financial measures, when analyzed in conjunction
with the Company's GAAP operating results, allows investors to more effectively
evaluate the Company's performance and provide investors management's view of
the Company's economic performance. The Company defines core earnings as GAAP
net income (loss) excluding (a) unrealized (gain) loss on derivative
instruments, (b) realized loss (gain) on termination of derivative instruments,
(c) amortization of unrealized (gain) loss of derivative instruments held at the
time of de-designation, and (d) realized loss (gain) on securities. The
following reconciles GAAP net (loss) income and net (loss) income per diluted
common share to core earnings and core earnings per common share:

                                                           Quarter Ended June 30                                                                         Six Months Ended June 30
                                           2020                                           2019                                             2020                                                2019
                               Amount             Per Share                 Amount                  Per Share               Amount                      Per Share                Amount                  Per Share
Net income (loss)           $       22,704           $       0.19            $     (63,460 )              $  (0.80 )        $         (181,949 )              $  (2.01 )          $     (71,206 )              $  (0.95 )

Unrealized (gain) loss on

non-designated derivative


  instruments                       (2,229 )                (0.02 )                 59,388                    0.70                      53,953                    0.57                   85,625                    1.01

Realized loss (net) on

termination of derivative


  instruments                        1,320                   0.01                   24,202                    0.28                     101,885                    1.07                   24,202                    0.28

Amortization of unrealized


  gain, net of unrealized
  losses on de-designated
  derivative instruments               122                   0.00                   (6,715 )                 (0.08 )                        19                    0.00                   (9,735 )                 (0.12 )

Realized loss on sale of


  investments                            -                      -                    1,365                    0.02                      67,820                    0.71                    1,365                    0.02
Core earnings               $       21,917           $       0.18            $      14,780                $   0.12          $           41,728                $   0.34            $      30,251                $   0.24


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Management believes that presenting financing spreads on residential mortgage investments, a non-GAAP financial measure, provides useful information for evaluating the performance of the Company's portfolio as opposed to total financing spreads because the non-GAAP measure speaks specifically to the performance of the Company's investment portfolio. The following reconciles these measures for the indicated periods:



                                              Quarter Ended June 30             Six Months Ended June 30
                                              2020               2019          2020                 2019
Total financing spreads                          1.52 %            0.34 %          1.03 %               0.38 %

Impact of yields on other


  interest-earning assets (a)                    0.04              0.01            0.02                 0.01

Impact of borrowing rates on other


  interest-paying liabilities (a)                0.09              0.05            0.07                 0.05

Impact of amortization of unrealized

gain, net of unrealized losses on


  de-designated Derivatives                      0.01             (0.24 )          0.00                (0.18 )

Impact of net interest cash flows on


  non-designated Derivatives                    (0.41 )            0.31           (0.15 )               0.24

Financing spreads on residential


  mortgage investments                           1.25              0.47            0.97                 0.50

(a) Other interest-earning assets consist of overnight investments and cash

collateral receivable from derivative counterparties. Other interest-paying

liabilities consist of unsecured borrowings and, at times, cash collateral


    payable to interest rate swap counterparties.


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                             RESULTS OF OPERATIONS

                                                     Quarter Ended              Six Months Ended
                                                        June 30                      June 30
                                                  2020          2019           2020           2019
Income statement data: (in thousands, except
per share data)
Interest income on residential mortgage
investments                                     $  48,133     $  85,100     $  117,361     $  168,907
Related interest expense                          (13,055 )     (67,945 )      (58,328 )     (131,724 )
                                                   35,078        17,155         59,033         37,183
Other interest income (expense)                    (1,878 )      (1,300 )

(3,379 ) (2,769 )


                                                   33,200        15,855         55,654         34,414
Other expense:
Loss on derivative instruments (net)               (6,948 )     (74,842 )     (162,687 )      (96,499 )
Loss on sale of investments (net)                       -        (1,365 )      (67,820 )       (1,365 )
Compensation-related expense                       (2,330 )      (1,972 )       (4,534 )       (5,581 )
Other general and administrative expense           (1,219 )      (1,138 )       (2,421 )       (2,266 )
Miscellaneous other revenue (expense)                   1             2           (141 )           91
                                                  (10,496 )     (79,315 )     (237,603 )     (105,620 )
Net income (loss)                               $  22,704     $ (63,460 )   $ (181,949 )   $  (71,206 )
Net income (loss) per diluted common share      $    0.19     $   (0.80 )   $    (2.01 )   $    (0.95 )
Average diluted shares outstanding                 95,887        84,934         95,276         84,914
Core earnings (a)                               $  21,917     $  14,780     $   41,728     $   30,251
Core earnings per diluted common share (a)           0.18          0.12           0.34           0.24

Key operating statistics: (dollars in
millions)
Average yields:
Residential mortgage investments                     2.33 %        2.82 %         2.42 %         2.79 %
Other interest-earning assets                        0.06          2.00           0.59           2.12
Total average yields                                 2.29          2.81           2.40           2.78
Average borrowing rates:
Secured borrowings (a)(b)                            1.09          2.35           1.45           2.29
Unsecured borrowings                                 7.72          7.73           7.72           7.71
Total average borrowing rates                        1.17          2.40           1.52           2.34
Average total financing spreads                      1.52          0.34           1.03           0.38
Average financing spreads on residential
mortgage investments(a)                              1.25          0.47           0.97           0.50
Average CPR                                         32.89         26.29          29.80          23.45
Average balance information:
Residential mortgage investments (cost basis)   $   8,257     $  12,065     $    9,691     $   12,117
Other interest-earning assets                         146           120            144             96
Secured borrowings                                  7,648        11,193          8,993         11,175
Unsecured borrowings (included in long-term
  investment capital)                                  98            98             98             98
Long-term investment capital ("LTIC")                 988         1,149          1,056          1,156
Operating costs as a percentage of average
LTIC                                                 1.45 %        1.09 %         1.32 %         1.20 %
Return on average common equity capital (c)         10.76          4.98           9.58           5.14

(a) See "Reconciliation of GAAP and non-GAAP Financing Measures" for a

reconciliation of these financial measures and the Company's rationale for

using these non-GAAP financial measures.

(b) Secured borrowing rates exclude the effects of amortization of the net

unrealized gains and losses included in Accumulated other comprehensive

income (loss) upon de-designation in 2019 of related derivatives held for

hedging purposes of 0.01% and (0.00)% and include net interest cash flows

from that date on non-designated derivatives of (0.41)% and (0.15)% for the

quarter and six months ended June 30, 2020, respectively, to better compare

the components of financing spreads on residential mortgage investments with

prior periods.


    basis over average common equity for the period.




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Capstead reported for GAAP purposes net income of $23 million and a net loss of
$182 million or $0.19 and $(2.01) per diluted common share during the quarter
and six months ended June 30, 2020, respectively. This compares to a GAAP net
loss of $64 million and $71 million or $(0.80) and $(0.95) per diluted common
share for the same periods in 2019. GAAP net income was negatively impacted
primarily in the first quarter by losses on derivatives of $156 million due
largely to lower prevailing interest rates and losses on sales of investments of
$68 million due to COVID-19 pandemic related disruptions to the fixed income
markets.

Capstead's core earnings, a non-GAAP financial measure, totaled $22 million and
$42 million or $0.18 and $0.34 per diluted common share for the quarter and six
months ended June 30, 2020, respectively, compared to core earnings of
$15 million and $30 million or $0.12 and $0.24 per diluted common share for the
same period in 2019. Core earnings in the first half of 2020 benefited from
lower borrowing rates while being partially offset by lower yields on its
residential mortgage investments and lower average portfolio balances following
asset sales in response to the COVID-19 pandemic in late March.

Interest income on residential mortgage investments was lower by $37 million and
$52 million for the quarter and six months ended June 30, 2020, respectively,
compared to the same periods in 2019. This decrease is attributable to $24
million and $31 million, respectively, in decreases related to lower average
portfolio balances and $13 million and $21 million, respectively, in decreases
related to lower average yields.

Yields on residential mortgage investments for the quarter and six months ended
June 30, 2020 decreased 49 and 37 basis points compared to the same periods in
2019, averaging 2.33% and 2.42%, respectively, primarily due to lower coupon
interest rates on loans underlying the Company's ARM Agency Securities that have
reset based on lower prevailing interest rates, as well as lower coupons on
acquisitions and other changes in portfolio composition. Yields were also
negatively impacted by higher premium amortization compared to the same periods
in 2019 due primarily to higher prepayment rates experienced on our portfolio.

Interest expense on secured borrowings was lower by $55 million and $73 million
for the quarter and six months ended June 30, 2020, respectively, compared to
the same periods in 2019. This decrease is attributable to $38 million and $51
million, respectively, in decreases related to lower average borrowing rates and
$17 million and $22 million, respectively, in decreases related to lower average
borrowings.

Secured borrowing rates, after adjusting for hedging activities, decreased 126
and 84 basis points for the quarter and six months ended June 30, 2020,
respectively, compared to the same period in 2019 to average 1.09% and 1.45%.
Market conditions contributed to lower borrowing rates, including three 25 basis
point decreases in the Federal Funds rate during the last half of 2019 followed
by 150 basis points in rate cuts in March 2020. Average fixed-rate swap payment
rates were 138 and 153 basis points for the quarter and six months ended June
30, 2020, respectively, compared to 220 and 211 basis points for the same
periods in 2019. This decline was largely due to efforts to reposition the swap
portfolio to take advantage of declining market interest rates over the course
of 2019 and a reduction in swap positions due to asset sales in the first half
of 2020. Currently-paying swap balances were lower, averaging $4.37 billion and
$5.73 billion for the quarter and six months ended June 30, 2020, respectively,
compared to $8.05 billion and $7.69 billion for the same periods in 2019. Future
secured borrowing rates will be dependent on market conditions, including
overall levels of market interest rates as well as the availability of
longer-maturity borrowings and interest rate swap agreements at attractive
rates.



Total operating costs, which include Compensation-related expense and Other
general and administrative expense, were higher by $439,000 during the quarter
ended June 30, 2020 compared to the same period in 2019. For the six months
ended June 30, 2020, total operating costs were lower by $891,000 compared to
the same period in 2019. The variance between the periods was primarily related
to adjustments to short-term incentive compensation in the respective periods.

                                      -30-

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                        liquidity and capital resources

Capstead's primary sources of funds are secured borrowings and monthly principal
and interest payments on its investments. Other sources of funds may include
proceeds from debt and equity offerings and asset sales. The timing, manner,
price and amount of any future common and preferred issuances and any common
stock repurchases will be made in the open market at the Company's discretion,
subject to economic and market conditions, stock price, compliance with federal
securities laws and tax regulations as well as blackout periods associated with
the dissemination of important Company-specific news.



The Company generally uses its liquidity to pay down secured borrowings to
reduce borrowing costs and otherwise efficiently manage its long-term investment
capital. Because the level of these borrowings can generally be adjusted on a
daily basis, the Company's potential liquidity inherent in its unencumbered
residential mortgage investments is as important as the level of cash and cash
equivalents carried on the balance sheet. The table included under "Utilization
of Long-term Investment Capital and Potential Liquidity" illustrates
management's estimate of additional funds potentially available to the Company
at June 30, 2020. The discussion accompanying this table and under "COVID-19"
provides insight into the Company's current liquidity position and perspective
on what level of portfolio leverage to employ under current market
conditions. The Company currently believes that it has sufficient liquidity and
capital resources available for the acquisition of additional investments,
repayments on borrowings and the payment of cash dividends as required for the
Company's continued qualification as a REIT.

Capstead finances its residential mortgage investments primarily by borrowing
under repurchase arrangements, the terms and conditions of which are negotiated
on a transaction-by-transaction basis, when each such borrowing is initiated or
renewed.

Future borrowings are dependent upon the willingness of lenders to participate
in the financing of Agency Securities, lender collateral requirements and the
lenders' determination of the fair value of the securities pledged as
collateral, which fluctuates with changes in interest rates and liquidity
conditions within the commercial banking and mortgage finance industries. None
of the Company's borrowing counterparties are obligated to renew or otherwise
enter into new borrowings at the conclusion of existing borrowings. Secured
borrowings totaled $7.58 billion at June 30, 2020, all maturing within 90
days. Secured borrowings began the year at $10.28 billion and averaged
$7.65 billion during the quarter ended June 30, 2020. Average secured borrowings
can differ from period-end balances for a number of reasons including portfolio
growth or contraction, as well as differences in the timing of portfolio
acquisitions relative to portfolio runoff.

To help mitigate exposure to rising short-term interest rates, the Company uses
derivatives supplemented with longer-maturity secured borrowings when available
at attractive rates and terms. At quarter-end the Company held $4.60 billion
notional amount of portfolio financing-related interest rate swap agreements
with contract expirations occurring at various dates through the second quarter
of 2022 and a weighted average expiration of 15 months. The Company also holds
swap agreements effectively locking in lower fixed rates of interest during the
20-year floating rate terms of the Company's $100 million face amount of
unsecured borrowings that mature in 2035 and 2036. The Company intends to
continue to utilize suitable derivatives such as interest rate swap agreements
or other derivatives and longer-maturity secured borrowings to manage interest
rate risk when available at attractive rates and terms.

During February 2020, Capstead issued 1.6 million shares of common stock through
an at-the-market continuous offering program at an average issue price of $8.21,
net of fees and other costs, for net proceeds of $12.9 million. Additional
amounts of equity capital may be raised in the future under continuous offering

                                      -31-

--------------------------------------------------------------------------------

programs or by other means, subject to market conditions, compliance with federal securities laws and blackout periods.

Interest Rate Risk



Because Capstead's residential mortgage investments consist almost entirely of
Agency Securities, which are considered to have limited, if any, credit risk,
interest rate risk is the primary market risk faced by the Company. Interest
rate risk is highly sensitive to a number of factors, including economic
conditions, government fiscal policy, central bank monetary policy and banking
regulation. By focusing on investing in relatively short-duration ARM Agency
Securities, declines in fair value caused by increases in interest rates are
typically relatively modest compared to investments in longer-duration ARM or
fixed-rate assets. These declines can be recovered in a relatively short period
of time as coupon interest rates on the underlying mortgage loans reset to rates
more reflective of the then-current interest rate environment. This strategy
also positions the Company to benefit from future recoveries in financing
spreads that typically contract during periods of rising interest rates.

Derivatives and longer-maturity secured borrowings transactions lengthen the
effective duration of the Company's secured borrowings to more closely match the
duration of its portfolio of residential mortgage investments. Including the
effects of derivatives held to hedge changes in secured borrowing rates, at June
30, 2020 the Company's residential mortgage investments and secured borrowings
had estimated durations of approximately 14 months and nine months,
respectively, for a net duration gap of approximately five months. The Company
intends to continue to manage interest rate risk associated with holding and
financing its residential mortgage investments by utilizing suitable interest
rate swap agreements or other derivatives and longer-maturity secured
borrowings, if available at attractive rates and terms.

Capstead performs sensitivity analyses to estimate the effects that specific
interest rate changes can reasonably be expected to have on net interest margins
and portfolio values. All investments, secured borrowings and related
derivatives held are included in these analyses. For net interest margin
modeling purposes, the model incorporates management's assumptions for mortgage
prepayment levels for a given interest rate change using market-based estimates
of prepayment speeds for the purpose of amortizing investment premiums and
reinvesting portfolio runoff. These assumptions are developed through a
combination of historical analysis and expectations for future pricing behavior
under normal market conditions unaffected by changes in market liquidity. For
portfolio valuation modeling purposes, a static portfolio is assumed.

This model is the primary tool used by management to assess the direction and
magnitude of changes in net interest margins and portfolio values resulting
solely from changes in interest rates. Key modeling assumptions include mortgage
prepayment speeds, adequate levels of market liquidity, current market
conditions, and portfolio leverage levels. A floor of 0.00% is assumed for all
pertinent indices except the Federal Funds Rate, which has no floor. However, it
is assumed that borrowing rates cannot decline beyond a floor of 0.15%. These
assumptions are inherently uncertain and, as a result, modeling cannot precisely
estimate the impact of higher or lower interest rates. Actual results will
differ from simulated results due to the timing, magnitude and frequency of
interest rate changes, other changes in market conditions, changes in management
strategies and other factors.

                                      -32-


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The table below reflects the estimated impact of instantaneous parallel shifts
in the yield curve on net interest margins and the fair value of Capstead's
portfolio of residential mortgage investments and related derivatives at June
30, 2020 and December 31, 2019, subject to the modeling parameters described
above.



                                 Federal     10-year U.S.
                                  Funds        Treasury         Down         Down          Up           Up
                                  Rate           Rate           1.00%        0.50%        0.50%        1.00%

Projected 12-month percentage


  change in net interest
margins: (a)(b)
June 30, 2020                   0.00-0.25 %           0.66 %     (40.6 )%     (14.3 )%      (0.5 )%      (3.6 )%
December 31, 2019               1.50-1.75             1.92         1.6          1.2         (0.6 )       (3.7 )

Projected percentage change
in
  portfolio and related
derivative
  values: (a)
June 30, 2020                   0.00-0.25             0.66         0.0          0.1         (0.4 )       (0.7 )
December 31, 2019               1.50-1.75             1.92        (0.1 )        0.0         (0.2 )       (0.4 )

(a) Sensitivity of net interest margins as well as portfolio and related

derivative values to changes in interest rates is determined relative to the

actual rates at the applicable date. Note that the projected 12-month net

interest margin change is predicated on acquisitions of similar assets

sufficient to replace runoff. There can be no assurance that suitable

investments will be available for purchase at attractive prices, if

investments made will behave in the same fashion as assets currently held or


    if management will choose to replace runoff with such assets.

(b) The change in the projected Down 1.00 and 0.50% scenarios at June 30, 2020

compared to December 31, 2019 primarily relates to the change in interest

rate environment caused by the 150 basis point declines in the Federal Funds

Rate in March 2020. The model assumes a floor on all pertinent market indices


    of 0.00% except the Federal Funds Rate, which has no floor. However,
    borrowing rates cannot decline below 0.15%.


                          CRITICAL ACCOUNTING POLICIES

Management's discussion and analysis of financial condition and results of
operations is based upon Capstead's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires the
use of estimates and judgments that can affect the reported amounts of assets,
liabilities (including contingencies), revenues and expenses, as well as related
disclosures. These estimates are based on available internal and market
information and appropriate valuation methodologies believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the expected useful lives and carrying values of assets and
liabilities which can materially affect the determination of net income and book
value per common share. Actual results may differ from these estimates under
different assumptions or conditions.

Management believes the following are critical accounting policies in the preparation of Capstead's consolidated financial statements that involve the use of estimates requiring considerable judgment:

• Amortization of investment premiums on residential mortgage investments -

Investment premiums on residential mortgage investments are recognized in

earnings as adjustments to interest income by the interest method over the

estimated lives of the related assets. Amortization is affected by actual

portfolio runoff (scheduled and unscheduled principal paydowns) and by

estimates and judgments related to future levels of mortgage prepayments that

may be necessary to achieve the required effective yield over the estimated

life of the related investment.

Mortgage prepayment expectations can change based on how current and projected changes in interest rates impact the economic attractiveness of mortgage refinance opportunities, if available, and other factors such as lending industry underwriting practices and capacity constraints, regulatory changes,


                                      -33-

--------------------------------------------------------------------------------

borrower credit profiles and the health of the economy and housing markets. Management estimates future mortgage prepayments based on these factors and past experiences with specific investments within the portfolio. Should actual prepayment rates differ materially from these estimates, investment premiums would be expensed at a different pace.

• Fair value and impairment accounting for residential mortgage investments -

Nearly all of Capstead's residential mortgage investments are held in the

form of mortgage securities that are classified as available-for-sale and

recorded at fair value on the balance sheet with unrealized gains and losses

recorded in Stockholders' equity as a component of Accumulated other

comprehensive income. Fair values fluctuate with current and projected

changes in interest rates, prepayment expectations and other factors such as

market liquidity conditions and the perceived credit quality of Agency

Securities. Judgment is required to interpret market data and develop

estimated fair values, particularly in circumstances of deteriorating credit


    quality and market liquidity. See NOTE 8 to the consolidated financial
    statements (included under Item 1 of this report) for discussion of how
    Capstead values its residential mortgage investments.


Generally, gains or losses are recognized in earnings only if securities are
sold; however, if a decline in fair value of a mortgage security below its
amortized cost occurs, the difference between amortized cost and fair value
would be recognized in earnings as a component of Other income (expense) if the
decline was credit-related or it was determined to be more likely than not that
the Company will incur a loss via an asset sale.

• Accounting for derivative instruments - Derivatives are recorded as assets or

liabilities and carried at fair value. Fair values fluctuate with current and

projected changes in interest rates and other factors such as the Company's

and its counterparties' nonperformance risk. Judgment is required to develop

estimated fair values.




The accounting for changes in fair value of each derivative held depends on
whether it has been designated as an accounting hedge, as well as the type of
hedging relationship identified. To qualify as a cash flow hedge for accounting
purposes, at the inception of the hedge relationship the Company must anticipate
and document that the hedge relationship will be highly effective and must
monitor ongoing effectiveness on at least a quarterly basis. As long as the
hedge relationship remains highly effective, changes in fair value of the
derivative are recorded in Accumulated other comprehensive income. Changes in
fair value of derivatives not held as accounting hedges, or for which the hedge
relationship is deemed to no longer be highly effective and as a result hedge
accounting is terminated, are recorded in earnings as a component of Other
income (expense).

The Company uses derivatives primarily in the form of interest rate swap
agreements to hedge the variability in borrowing rates on its secured and
unsecured borrowings. For derivatives designated as accounting hedges, fixed
interest payments and variable interest receipts are recorded as an adjustment
to interest expense on the related designated borrowings. For derivatives not
designated as accounting hedges, fixed interest payments and variable interest
receipts are recorded as a component of Other income (expense). For derivatives
initially designated as an accounting hedge and subsequently de-designated, any
unrealized gain or loss included in Accumulated other comprehensive income at
the time of de-designation is amortized as an adjustment to interest expense on
the related borrowings over the remaining term of the derivatives.  See NOTE 6
to the consolidated financial statements (included under Item 1 of this report)
and "Financial Condition - Secured Borrowings" for additional information
regarding the Company's current use of derivatives and its related risk
management policies.

                                      -34-

--------------------------------------------------------------------------------


                STATEMENT CONCERNING 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," "will be," "will likely
continue," "will likely result," or words or phrases of similar
meaning. 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:

• fluctuations in interest rates and levels of mortgage prepayments;

• changes in market conditions as a result of federal corporate and individual

income tax reform, federal government fiscal challenges and Federal Reserve

monetary policy, including policy regarding its holdings of Agency and U.S.

Treasury Securities;

• liquidity of secondary markets and credit markets, including the availability

of financing at reasonable levels and terms to support investing on a

leveraged basis;

• the impact of differing levels of leverage employed;

• changes in legislation or regulation affecting Agency Securities and similar

federal government agencies and related guarantees;

• deterioration in credit quality and ratings of existing or future issuances

of Agency Securities;

• the effectiveness of risk management strategies;

• the availability of suitable qualifying investments from both an investment

return and regulatory perspective;

• the availability of new investment capital;

• the ability to maintain real estate investment trust ("REIT") status;

• changes in legislation or regulation affecting exemptions for mortgage REITs

from regulation under the Investment Company Act of 1940;

• negative impacts from the ongoing novel coronavirus (COVID-19) pandemic

including on the U.S. or global economy or on our liquidity, financial

condition and earnings;

• other changes in legislation or regulation affecting the mortgage and banking

industries; and

• changes in general economic conditions, increases in costs and other general

competitive factors.




In light of the ongoing COVID-19 pandemic, several of the risks and
uncertainties described above are more likely to occur and/or the potential
impact therefrom is harder to estimate. In particular, the impact of COVID-19 on
fluctuations in interest rates and levels of mortgage prepayments, liquidity of
secondary markets and credit markets, including the availability of financing at
reasonable levels and terms to support investing on a leveraged basis, and
changes in general economic conditions, are especially unclear at this time.
Given this unprecedented uncertainty, actual results could differ materially
from those anticipated or implied in the forward-looking statements included
herein. In addition to the above considerations, actual results and liquidity
are affected by other risks and uncertainties which could cause actual results
to be significantly different from those expressed or implied by any
forward-looking statements included herein. 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. 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. Accordingly, readers of this document are cautioned not to
place undue reliance on any forward-looking statements included herein.

For a further discussion of these and other factors that could impact our future
results and performance, see "Risk Factors" under Part I, Item 1A of our Annual
Report on Form 10-K for the year ended December 31, 2019, filed with the U.S.
Securities and Exchange Commission on February 21, 2020.

                                      -35-

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Capstead Mortgage Corporation Announces Management Changes	21-10-19	CI
Capstead Mortgage Corporation's Equity Buyback announced on January 31, 2018, has expired.	21-10-18	CI
Benefit Street Partners Realty Trust, Inc. completed the acquisition of Capstead Mortgage Corporation from Blackrock Inc., The Vanguard Group, Inc., T. Rowe Price Associates, Inc., Paradice Investment Management LLC and others.	21-10-18	CI
Capstead Mortgage : Stockholders OK Franklin BSP Realty Trust Deal	21-10-15	MT
Capstead Mortgage : Declared Interim Dividend of $0.014 per Common Share, Payable Oct. 18 to Stockholders of Record as of Oct. 13	21-10-07	MT
Capstead Mortgage Corporation Declares Interim Common Dividend, Payable on October 18, 2021	21-10-07	CI
Capstead Mortgage : Lowers Q3 Dividend to $0.0725 a Share From $0.15, Payable Oct. 15 to Shareholders of Record Sept. 30	21-09-17	MT
Capstead Mortgage Corporation Declares Third Quarter 2021 Common Dividend, Payable on October 15, 2021	21-09-16	CI
Capstead Mortgage Corporation Reports Earnings Results for the Second Quarter Ended June 30, 2021	21-07-28	CI
Capstead Mortgage : Earnings Flash (CMO) CAPSTEAD MORTGAGE CORPORATION Posts Q2 EPS $0.09, vs. Street Est of $0.15	21-07-28	MT
Capstead Mortgage : to Merge with Benefit Street Partners Realty Trust; Shares Rise	21-07-26	MT
Transcript : Benefit Street Partners Realty Trust, Inc., Capstead Mortgage Corporation - M&A Call	21-07-26
Benefit Street Partners Realty Trust, Inc. entered into a definitive merger agreement to acquire Capstead Mortgage Corporation from Blackrock Inc., The Vanguard Group, Inc., T. Rowe Price Associates, Inc., Paradice Investment Management LLC and others for approximately $680 million.	21-07-25	CI
Capstead Mortgage Corporation(NYSE:CMO) added to Russell 3000E Value Index	21-06-25	CI
Capstead Mortgage Corporation(NYSE:CMO) added to Russell 2000 Defensive Index	21-06-25	CI
Capstead Mortgage Corporation(NYSE:CMO) added to Russell 2000 Value-Defensive Index	21-06-25	CI
Capstead Mortgage Corporation(NYSE:CMO) added to Russell Microcap Index	21-06-25	CI
Capstead Mortgage Corporation(NYSE:CMO) added to Russell 3000E Index	21-06-25	CI
Capstead Mortgage Corporation(NYSE:CMO) added to Russell Microcap Value Index	21-06-25	CI
Capstead Mortgage Corporation Declares Dividend for the Second Quarter 2021, Payable on July 20, 2021	21-06-10	CI
Transcript : Capstead Mortgage Corporation, Q1 2021 Earnings Call, Apr 29, 2021	21-04-29
Capstead Mortgage Corporation Reports Earnings Results for the First Quarter Ended March 31, 2021	21-04-28	CI
Capstead Mortgage : Earnings Flash (CMO) CAPSTEAD MORTGAGE CORPORATION Posts Q1 EPS $0.13, vs. Street Est of $0.16	21-04-28	MT
Capstead Mortgage Corporation Declares Dividend for the First Quarter 2021, Payable on April 20, 2021	21-03-11	CI
Tranche Update on Capstead Mortgage Corporation's Equity Buyback Plan announced on January 31, 2018.	21-02-19	CI

Capstead Mortgage Corporation

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CAPSTEAD MORTGAGE : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL (form 10-Q)

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