Lindsey Crabbe - Investor Relations Phil Reinsch - President and Chief Executive Officer Robert Spears - EVP & Chief Investment Officer.

Erick Diaz - KWB Steve DeLaney - JMP Securities Jack Moreno - Colorado Wealth Management Fund.

Good morning and welcome to the Capstead Mortgage Third Quarter Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions [Operator Instructions]. Please also note this event is being recorded.

I'd now like to turn the conference over to Lindsey Crabbe with Investor Relations. Please go ahead..

Good morning thank you for attending Capstead's third quarter earnings conference call. Third quarter earnings release was issued yesterday October 26th and is posted on our Web site at www.capstead.com under the Investor Relations tab.

The link for this webcast is also in the Investor Relations section of our Web site, an archive of the webcast will be available for 90 days. A replay of this call will be available through January 18th, 2017. Details for the replay are included in yesterday's release.

With me today are Phil Reinsch, President and Chief Executive 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 October, 27th 2016.

The Company assumes no obligation to update any statements, including any forward-looking statements made during this call. With that, I will turn it over to Phil..

Thank you Lindsey, good morning and welcome everyone. I want to mention several items that stand out relative to our third quarter earnings. Then we'll open the call up to questions.

First of all, we recorded a $2.7 million charge in the third quarter equating to roughly $0.03 per share relating to costs associated with the July resignation of Andy Jacobs, our former CEO.

By segregating these costs on the income segment into a distinct separation service charge our remaining operating cost will be more indicative of our business going forward. We expect to remain a leader amongst our mortgage REIT peers in terms of operating cost efficiency.

Secondly our earnings excluding the separation of service charge declined by about $0.03 over second quarter results to $0.16 per share with the primary driver of the decline being higher investment premium amortization as a result of higher mortgage prepayment levels.

Prepayments came in about 11% higher in the third quarter at a CPR of 25.8% with September expected to be high water mark for prepays this year. With the bulk of this year's refinancing and the summer selling season behind us we can expect to see improved portfolio yields and earnings in the coming quarters.

The last point to mention is that despite the recent prepay headwinds our strategy of owning agency guaranteed ARM securities is working in our favor, with cash yields increasing as mortgage loans underlying our portfolio continue resetting hiring rate based on higher prevailing six and twelve months interest rate indices.

They key feature of our portfolio together with our use of relatively cost effected two and three year interest rate swaps provided the measure of protection against rising short-term interest rates both in terms of earnings power and book value stability.

Illustrating our book value stability changes in unrealized gains and losses on our portfolio and related swaps resulted in the decline of 0.1% in book value for the third quarter. That’s $0.01 per share and a 0.1% increase over the nine months ended September 30.

The remaining $0.10 per share declines in book value this quarter was the result of returning capital directly our stockholders in the form of dividend distributions in access of our earnings.

Similar returns of capital back to our stockholders occurred last quarter and in the summer quarters of last year, primarily as a result of earnings short falls relative to the common dividend paid because of higher refinancing activity than what was anticipated when the dividend rate was established.

While we knew we would not earn 100% of our common dividend this summer, rather to reduce the dividend to be reflective for the current quarter results, we continue to evaluate how we expect to perform on an ongoing basis with the node to providing some stability in resulting dividend run rate. With that I'd like to open the call up to questions..

Thank you. [Operator Instructions] The first question comes today from Bose George with KWB. Please go ahead..

Thanks good morning guys its Eric. Can you tell the prepay speeds between the current reset bucket and the longer reset bucket.

And then of course your assumptions for what those are going to be over the next year, especially as LIBOR has risen?.

Hello Eric this is Phil. We don’t make a public disclosure of that breakout between our current reset and longer reset portions of our portfolio.

However the longer resets has been prepaying at a much faster rate than our more seasoned current reset paper, which we are seeing higher prepay as loans due approach their first reset date which is a portion of our current reset portfolio as well..

And since LIBOR has risen since the end of June, what do you think the prepay speeds will be on that longer reset bucket this quarter and then into next year?.

Yes Derek this is Robert. Generically if you look at the cohorts that are out there, various season post resets are prepaying in the high teens right now and what we classify as longer resets which are high on demand and varying in states of reset are prepaying in the mid to high 20s generically.

And so over longer periods of time, with the yield curve as flat as it is I still think you have got some burnout protection in the various seasons post to reset.

So I think high teens is probably a good number for that and as rates go up the bonds that are trending in the upper 20s, I think you could see that come down, as they’re [indiscernible] is to refinance..

Okay, okay so if we run with the assumption -- I guess where I struggle is, have those assumptions for the longer reset bucket, have they changed at all since -- over the last few months. I mean I think -- I don't want to speak for anyone, but it seemed to me anyway that the bump up in LIBOR was a little bit surprising.

And I think a lot of people expected it with money market reform changes, but the move itself was a little surprising.

So have your expectations changed? You don't have to give me any numbers around it necessarily, but are they faster now than they were call it three or four months ago?.

The longer reset bucket is not as driven by LIBOR as the actual coupon rates, these bonds are fixed in coupon for -- you know they have an average of 40 something months to roll, so that's more driven by current mortgage rates, not the bump up in LIBOR.

The bump up in LIBOR would affect ARMs that are resetting for the first time or post reset, et cetera. And so all I can say at this point is the very season post resets are not ramping up in speed as fast as a lot of people expected. They're still kind of running in the high teens and it looks like they may stay there for a while.

The longer reset that you're asking about, they should slow down given the rise in the rates we’ve had over the last month or so, you know a 30 year no cost refinance rate is back up to around 300 [ph] a quarters again, and so those are going to be driven more by current mortgage rates as opposed to LIBOR..

Okay, alright and then you know I've been thinking a lot lately about just the life cycle of an ARM and I see that your longer reset bucket is trading around you know call it 104 and I'm looking at a dealer report from the beginning of October that says, new issue 51 ARM is trading around the same price.

Can you remind us what your assumptions are for what that bond turns into in price as it approaches its current reset period?.

Well I mean -- you have to look at this with a very long time frame. So let's say a new issue 51 2.5 is trading around 103, those bonds if that had LIBOR plus 160, 70 years from now that kind of paper is trading with a 105 handle.

And so in theory if the curves stays at this slope that it’s at now and the tail was worth the same, that bond would appreciate a couple of points in price over that seven year life cycle. Now obviously you take prepaid, it's along the road, and by the time it’s trading with a 105 handle your bonds factor down you know 10% or 15%.

So, you have a couple of points in upside if the curves stay afloat like it is based on where the securities are trading now..

So that relationship between, call it 103 and 105 give or take should hold up over the next foreseeable future?.

It should but also by the same token you're not getting -- it's not a linear bump. You know that 51 two years from now because it’s in -- it’s ramping up in speed may still be trading at -- in this example maybe still be trading at 103.

It may take -- and then as it goes through its pay downs and burn out and you're left with just a slower-slower cohort [indiscernible]. So it's not a linear function.

Does that make sense?.

And I guess one more for me if you don’t mind. If you could just share how current reset ARMs have performed since the end of the quarter over the last three or four weeks, that will be great..

Season post resets are doing very well right now. If you just look at the market in general new issued 51s since the end of the quarter are probably down a quarter a point, very seasoned post resets are unchanged and in some cases maybe up a couple of ticks in price.

So they are behaving very well, so at this juncture the increase in LIBOR and the higher coupon is definitely offsetting any prepayments [indiscernible] those bond because they continue to trade well and they are prices are very firmed..

Our next question is from Steve DeLaney with JMP Securities. Please go ahead..

Let's start with operating expenses I mean this has been a characteristic of caps dead for long time one of the lower expense ratios, but still its 73 basis points this quarter it really seems to jump around a lot I guess that has to do with your incentive comp accrual.

So I guess my question is over the course of a year do you have a range that you are targeting to try to keep expenses within knowing that you are -- you take part on being the lowest -- at least historically you’ve been the lowest in expenses..

Yes there is plenty noise in this quarter with the changes we had really in the quarter. And we haven’t filled out our management team with the new CFO this point. So it’s not 73, arguably messed up by that. Historically, we have been in the 90 basis point range, 80 to 100.

And it does move a lot with our incentive accruals and our comp is kind of a lot of its based on relative performance to the mortgage REIT peer group and that can be -- give you some different answers than you might expect at times..

So two things, it sounds like you would like to see at maybe come in under 100 basis points overtime and then can you give us an update on your CFO search?.

I haven’t placed anybody yet. We need to get somebody in place, but we haven’t been able to accomplish that yet..

I am guessing you haven’t forgotten everything you know in the last few months?.

Well that’s true, we got a great team here extremely strong controller and we can handle it in time without any issues..

So my second question, I want to go back to the portfolio picking up on where Eric was. So Robert you showed your new purchases in the quarter, you are showing a lifetime yield of 210 basis points. And assumed those are seasoned hybrids primarily. The portfolio yield for the quarter admitted with high speed which was 146.

So I guess the obvious question there especially given -- and I think the interesting thing is it’s really the seasoned hybrids that seem to be more sensitive to refi than it is the post resets as you described.

But just assume you are taking -- you’ve got higher light speeds factored in your 210 yield, why -- maybe help me to understand why with 57% of the portfolio still in post reset, given that that difference in yield, why wouldn't you do a little rebalancing of the portfolio assuming that the bid of short ARMS is still strong, and try to take advantage of that, that step up in yield?.

Well first of all Steve those are lifetime yields, so that's not necessarily representative of the cash flows that we would get in the earlier, earlier [technical difficulty]..

Okay good point..

I would say generically we're kind of looking at spreads in the 90 basis point area versus either REPO or swaps given how we hedged the book and so you can deliver [ph] nine times, we're talking about 10% finish type returns right now and so you know the issue with the post resets is our basis is low enough that we got really good carrying response and we don’t -- they’ve had normal hedging requirement.

You know that's always the trick, when do you sell those resets, I mean we're kind of in it, if you look at where they're trading now versus where they’ve traded over the last couple of years, we're kind of in the middle of the range. I mean they've been a point higher and they've been a point lower at the widest point in spreads.

So they’re in the middle of the range and they're throwing off really nice cash flows right now. So they're very hard to replace and the speeds are much more predictable than new issue hybrids.

So we just like the balance of the two and we have bought short resets over this year for the first time in a while, mostly earlier in the year, so we like the balance that it provides to the portfolio. I mean we always look at whether we should sell bonds or not, at this juncture we're more inclined to hold on to them..

Got it, got, that's good color yes, especially if you're not at the highest in terms of prices, so thanks for the comments guys..

[Operator Instructions] our next question comes from Jack Moreno with Colorado Wealth Management Fund, please go ahead..

Hey guys, you grow slack average 3.26 over the last quarter, can you give us some color on the top end from mortgages included in the portfolio.

And how much of an increase we need to see in the 30 year fixed rate pools to get amortization to fall further than we would expect just from the normal seasonal factors?.

I'm sorry, you're breaking up I didn't really hear the question, can you say that again?.

Yes, sure, sorry about. The gross slack came in at 3.26%, can you give us some color on how much of an increase we need to see in the rates on 30 year fixed pool for the amortization charges to decline more than we would expect from the seasonal factors..

Okay sure I heard that, as I mentioned earlier the 30 year no cost refinances is around three and three quarters. Within that 3.6 net slack that is going to go up based on our shorter resets.

So it's probably going to go up if you look at the shorter resets that are going to increase about 25 basis points that gross slack is going to go up over the next few months, between an eight and a quarter of a point.

Having said that, as I mentioned earlier the 30 year mortgage fixed rate right now had more of an impact on our longer reset paper than it does on our very seasoned post reset, because some of those have already adjusted the higher rates than fixed rates and they’re still not repaying that fast.

And so given the current slope in the curve it brings no change at all, we expect to see just based on seasonal and what we’ve already got October prepaid for out and generically ARMs came down about 10% in October from where they were in September. And they should continue to decline more in the fourth quarter.

It can sense that much season general third to fourth quarter maybe down about 10%. And so what we are seeing -- and obviously if fixed rate go up more and the curve steepens more that’s only going to help our portfolio speeds in the future..

We lost Jack..

Yes we did and we have no others in the queue at the moment. This concludes the question and answer session. I would like to turn the conference back over Lindsey Crabbe for closing remarks.

Thanks again for joining us today. And if you have any further question please give us a call. We look forward to speaking with you next quarter..

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