Lindsey Crabbe - Andrew F. Jacobs - Chief Executive Officer, President, Director and Member of Executive Committee Robert R. Spears - Chief Investment Officer and Executive Vice President.

Steven C. Delaney - JMP Securities LLC, Research Division Joel Jerome Houck - Wells Fargo Securities, LLC, Research Division Michael R. Widner - Keefe, Bruyette, & Woods, Inc., Research Division.

Good morning, and welcome to the Capstead Mortgage First Quarter 2015 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Lindsey Crabbe. Please go ahead..

Andy Jacobs, President and Chief Executive Officer; Phil Reinsch, Executive Vice President and Chief Financial Officer; and Robert Spears, Executive Vice President and Chief Investment Officer.

Before we get started, I want to remind you that 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 1995 and are based on certain assumptions and expectations of management.

For a detailed list of all the risk factors associated with our business, please refer to our filings with the SEC, which are available on our website. The information contained in this call is current only as of the date of this call, April 30, 2015.

The company assumes no obligation to update any statements, including any forward-looking statements made during the call. With that, I'll turn the call over to Andy..

Well, good morning, and welcome to our first quarter earnings call. Just a quick overview, I'll be very brief actually in my comments and get to questions. As we know, the 10-year Treasury has been quite volatile this year.

We began the year at 2.17%, rallied to 1.64% at the end of January, back up to 2.25% in early March, ended the quarter at 1.92% and currently, I think, this morning when we walked in here, it was about 2.07%. So it's been quite a volatile time.

And there -- obviously, there continues to be a significant amount of uncertainty regarding the timing of the first Fed rate hike. And yesterday in the Fed's announcements, they said they would take into account a wide range of information before they begin to raise their target rate.

And obviously, using old words, they used to call that data dependent, and we all know what that means. Anyway, this rate volatility and continued uncertainty has been challenging, particularly for investors trying to manage a portfolio of fixed-rate mortgage securities. So far this year, ARM securities have outperformed fixed-rate securities.

And because of our focus on the short-duration mortgage securities, we've not had to reposition our investment portfolio or adjusting our hedging strategy to deal with the rapidly changing rate environment. And I think you'll recognize this is consistent with how we manage through in 2013 through the taper tantrum.

All in all, for the quarter, our book value declined less than 0.5% to $12.47. Now speaking relative to the first quarter results. Briefly, we had $34 million in net income, $0.32 per common share, and we paid a dividend of $0.31. Net interest margins were $37.4 million, and our financing spread was up 1 basis point from the previous quarter.

And prepayments were the answer to the difference here. Our prepayments speeds [ph] to CPR declined to 16.66% CPR from 17.58% in the fourth quarter. And as I've previously said in calls, each full percentage point change in CPR quarter-over-quarter is worth upwards to about $1.5 million in premium amortization, plus or minus, whichever way it goes.

Again, this is a bit over simplified as actual amortization will be bond specific, but it's close. So during the first quarter, the almost full point change -- decline in CPR translated into that $1.1 million in less premium amortization, which, as a result, the real rule of thumb is still valid.

Borrowing rates, including hedging costs, averaged 59 basis points during the first quarter, which was 3 basis points higher than the borrowing rates in the previous quarter. This was due largely to the use of higher rate loan maturity repos, and we had some of our lower rate swap agreements that burned off through the period.

The duration of our investment portfolio remains one of the lowest in the industry at 11 months, and that's the asset side of it. After considering the liability side, which is about a 9-month duration, our net duration is at 2 months. Our operating cost as a percentage of our long-term investment capital averaged 94 basis points.

And again, I'm confident this will make us the most cost-efficient platform in the mortgage REIT community. Portfolio wise, we increased the size of our portfolio to $14.15 billion at the end of the quarter, which is slight -- and we increased slightly our leverage ratio to 8.65:1.

And I think as you've heard us say before, we're comfortable with this level of leverage especially with managing the short duration character of our portfolio. Few final remarks. The mortgage prepayments are going to be key to our portfolio yields in coming quarters.

And as we stated yesterday, prepayments increase for the month of May and that we now anticipate lower yields in the second quarter due to higher premium amortization that we expect. And with that, I'll open for questions..

[Operator Instructions] And our first question will come from Steve Delaney of JMP Securities..

Andy, you commented about prepays in the quarter. I was wondering if you or Robert could give us a breakdown of the 16.7% rounded.

Can you give us a sort of a trend of how that played out January, February, March in the quarter as the quarter went along?.

Yes, sure. Steve, I'll take that. Basically, the generic ARM universe prepaid kicked up about a quarter of the CPR. Ours has actually declined though, and that was because of the composition of our book. And basically, our very seasoned short recess declined more than longer recess hybrids.

And so, those have been kind of consistently paying in the 10% to 12% area. At the same time, the biggest percentage increase you saw in ARM prepays, generically, was in new issues 7 1s and 10 1s [ph], which we don't own any of those.

So because of the composition of our book, mainly driven by our season short recess which aren't as -- not as affected by rates, but our book declined more than you would expect from the generic ARM prints..

And so, should we see the seasonal aspect where obviously, January, February are heavily impacted from the holidays? Should we assume that March was probably, sequentially, a faster speed than, say, January, February?.

Yes, absolutely. I mean, I think, if you just -- if you look forward, if you just look at once again the generic ARM universe, if you look in March had roughly 17-ish-type CPR. April increased to around 20 CPR. And they should come down a little bit in May and June.

And then, July could kick back up again because of the recent rally and trying to project much further out than 4 months right now, it's very difficult given the volatility in the Treasury market..

Understood. I mean, just looking backwards, I guess, looking back a couple of quarters, you were sort of in the 19 CPR in third quarter of last year..

Yes. We saw a bigger decline in February than you would expect. And then, they started trending back up in March..

Okay. And then shifting to your term repo.

How many of your 25 counterparties are actually going out 12 months or longer with you at this time?.

We have positions along with 2 -- we probably have -- we have positions with 3, excuse me. We probably have 5 or 6 guys that we could do term stuff with..

Okay, great. And as we think about that, Robert, I mean, you're sort of -- as you're going out 2 years, you sort of eliminate the need to have -- you've got fixed rate. You don't need swaps.

So when you sort of look at your notional swap balance, is it possible that goes down? And when you think about swap coverage of repo, I guess, we should be thinking about coverage or short repo rather than total repo as we may have in the past..

Sure. I mean, we do. We look at 2-year repo versus 2-year swaps. And given where one is versus the other at that in time, whichever one was more favorable to us, we'll execute that trade. Obviously, the biggest benefit for 2-year repo versus 2-year swaps is that it's committed financing. It's -- we're willing to pay up for that.

But we view it in the context of our overall hedge book and we look at a 2-year repo just like we look at a 2-year swap and calculating our duration gap, et cetera. And so we -- that's always something we look at before we determine whether we're going to put a swap on versus a long-term repo..

Yes. One nuance with the swaps versus the longer repo is that the swaps actually are mark-to-market on an ongoing basis, whereas the longer dated repo is not..

Yes. That could certainly add to some book value stability here..

Yes..

Our next question comes from Joel Houck of Wells Fargo..

Wondering if the $926 million of portfolio acquisitions in the quarter, can you give us what the average term or I should say counter is on that?.

Well, we didn't disclose that. But basically, we really haven't deviated from our strategy. We're buying a combination of new issue and season bonds, but we're -- for the most part, not going out more than 60 months to reset. So it hasn't changed from what we bought over the last several quarters..

Okay.

And so, when you kind of look at the average -- or not average, but if you look at the portfolio and months to reset, that one would assume, it hasn't materially changed either over the past several quarters?.

No. If you look at Page 12 of 12 that shows our short reset versus long reset. The percentages haven't changed materially at all nor have our months to reset..

Okay. And given, I think, a lot of your peers struggle with hedging and minimizing book value volatility. Given that your portfolio is naturally shorter in duration, you're not -- obviously, you're not as exposed in the long end of the curve. You took the leverage up a little bit.

What's the -- can you remind us again kind of maybe the tolerance limits or levels of leverage that you're willing to run in your business model?.

Well, I mean, I think we've been recently somewhere between 8x and 9x, but pretty much clustered around 8.5x. And given where speeds are right now, between 15 and 20 CPR, generically, on our portfolio, I think somewhere 8.5x, we're very comfortable with that level.

And as you mentioned, the part of the curve we're on, there hasn't been a ton of volatility on the 2-year part of the curve. So it does make hedging our book easier..

And our next question is from Mike Widner of KBW..

I'm sorry if you addressed this, I had to jump on a little bit late. But I was surprised to see that the prepay speeds came down slightly, even with the seasonality we thought that we might see a pickup with the rates moving a lot lower in January as they did.

How was the April speed looked and what are you guys thinking for the rest of the quarter?.

Yes, Mike. Looking at our speeds coming down more, but I mentioned earlier, our seasoned post reset declined more than the aggregate ARM universe. So that's what drove our speed lower in the first quarter for the most part.

And then, if you look at it -- once again, we haven't disclosed our April speeds, but generically, the ARM universe speeds kicked up from around 17 CPR in March to around 20 CPR in April. And I think, that's kind of -- and they should drop somewhat in May and June and then kick back up again in July..

Okay. And when you say they should kick back up again in July, I mean, you mean that just on the basis of seasonality or....

Well, just looking at the volatility in the Treasury market, early on, when we were 2.25% on 10s, it was kind of assumed that April may be the high print. But we subsequently rallied back down to 1.85%. Now we're at 2.05% so that recent rally will probably translate into July production.

And so, those speeds are probably going to be a little faster than what you see in May and June. And then from there, it's kind of anybody's guess. But yes, seasonality affected us well. But just from a rate standpoint, given the volatility, it's very hard to project out more than 3 or 4 months on speeds right now..

Yes. I mean, that certainly makes sense. So I mean, at the end of the day, all else equal, just given the April data and kind of what we're looking at and we should probably figure on a slight increase in CPR in 2Q, and I guess obviously we'll take it from there..

Yes. Absolutely. I mean, if you look at -- we already have April in the books, right? And they're going to come down somewhat, but they're definitely going to be faster than what we saw in the first quarter..

Yes, Mike, I think it's important to make -- our focus here, when you're looking at our company, we're going to be very much prepayment rate driven, as to the ebbs and flow relative to that, whereas you can be confident that we're going to be consistent with the types of assets we're buying and the hedging of it.

And so, that's going to be a very constant focus for us. And you're not going to see tremendously wild swings relative to that in our book..

And so, actually, I guess on that front, I mean, you guys have been pretty consistent in the mix of current resets versus longer to reset ARMs for, I don't know, quite a while now. And I expect that's going to remain the case.

But it sounds like you're pretty explicitly saying that you expect that to remain the case, you're still buying sort of the same stuff and letting them drift down and just trying to keep that mix about where it is?.

Yes. That's right. I mean, a lot of the reason why that mix is staying the same, we're not buying as much of the older seasoned short reset paper, but we've got natural roll down in our book that pushes what we classify as longer resets into the shorter reset category.

And then on top of that, our very seasoned short recess prepay is lower than our longer resets. So given the mix of assets we're buying and the duration gap that we're targeting, we shouldn't see much variance in those numbers..

[Operator Instructions] I'm showing no further questions. I would like to turn the conference back over to Lindsey Crabbe for any closing remarks..

Thanks again for joining us today. If you have further questions, please give us a call. We look forward to speaking with you next quarter..

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..