Lindsey Crabbe - IR Phillip Reinsch - President & CEO Robert Spears Jr. - EVP & CIO.

Steven Delaney - JMP Securities.

Good morning and welcome to the Capstead First Quarter 2017 Earnings Conference Call. All participants will be in listen only mode. [Operator Instructions]. After today's presentation there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.

I would now like to turn the conference over to Lindsey Crabbe Manager of Investor Relations. Please go ahead. .

Good morning. Thank you for attending Capstead's first quarter earnings conference call. The first quarter results release was issued yesterday April 26 and is posted on our website at www.capstead.com under the Investor Relations tab.

The link to this webcast is also in the Investor Relations section of our website and an archive of the webcast will be available for 90 days. A replay of this call will be available through July 27, 2017. Details of the replay are included in yesterday's release.

With me today are Phillip 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, April 27, 2017.

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

Good morning, welcome everyone. I know this is a busy morning for earnings call, so I will keep my comments brief, then we will open the call up to questions.

The interest rate market that we navigate continue to be volatile as evidence by the 225 basis points increase in the fed funds rates since December and sharply higher longer-term rates post-election. More recently, uncertainty regarding geopolitics and the pace of change in Washington has weighed on longer-term interest rates. Still U.S.

interest rates across the yield curve are significantly higher than they were pre-elections. Against this backdrop, we earned $0.20 per common share in the first quarter for an annualized return on common equity of 7.4%, this is up from $0.14 in the fourth quarter.

Together with a $0.14 increase in book value this quarter attributed to improved pricing on our agency ARM portfolio and our slot positions, we've produced an annualized economic return of 12.5% for the first quarter.

This follows an economic return performance for the fourth quarter that outstrip returned produced by all but one of our peers and invest primarily an agency guaranteed mortgage securities, and most of our non-agency residential mortgage peers [ph] as well.

The primary driver of our improved first quarter results was a 10% sequential decline in quarterly mortgage prepayment levels which contributed to lower yield adjustments for investor premium amortization. Importantly, higher ARM loan coupon interest rates contributed to higher cash yield, which offset increased borrowing rates during the quarter.

This admittedly gradual resetting of cash yields on our portfolio is a key feature of our short duration ARM investment strategy which together with the prudent use of short-term interest rate swap agreements can help offset higher borrowing costs overtime.

As such, and as has been borne out in past periods of market instability, we believe we are well positioned to preserve our stockholders capital while generating attractive risk-adjusted returns over long-term investment horizons.

More immediately, mortgage prepayment levels in the coming months and quarters, as well as the pace of future increases in short-term interest rates remain key to our near-term results. With that, I'll open the call up to questions. .

[Operator Instructions] The first question comes from Steven Delaney with JMP Securities. Please go ahead..

Thanks, good morning. Phil, could you comment -- you've got a nice pick up on earnings from the 10% drop in CPR, so averaged about 23% in the first quarter.

I was wondering if you or Robert could comment sort of on how that played out sequentially kind of month-to-month, and if you'd be willing to comment on what April looked like, it looked to us like the April factors might've turned up about 20% across the board for the agency MBS Universe. I am just curious what you guys saw. Thank you..

Sure, first quarter peak stays at ARM market were actually January trend, and then they fail down over the course of a quarter and averaged out. So just under 23% CPR for us. If you look at ARM's generically, the April trends are out and they are up about approximately 20% from the March trend.

So it's kind of behind the fixed rate albeit at a much higher level than fixed rate but the percentages are about the same. It should trail up a little bit in May because day count was lower and then pick back up again in June..

Yes, most of that pick-up was day count related..

Which pick-up Phil, just so I understand. I know the day count really matters..

Yes, the speed pick up for April was day count related and it's going to go back the other way for the May trend..

Got it, got it.

But I mean realistically given kind of where ARMs are now and where they're resetting; I guess the big issue here is stepping back is really the flattening of the curve in terms of attractiveness of different products, but it would seem reasonable for us to just sort of think that speeds are going to have a kind of a low 20 handle over the next couple of quarters, does that sound reasonable to you guys.

.

Well, I mean if you look at the cohorts [ph] out there, what you're seeing is kind of interesting phenomenon now for the longest time, longer resets will prepaid faster than short resets, that's flip flop now and so you've got to see that short resets they're kind of trending in the mid 20 now.

Longer resets if you look at our long reset grow up for coupons to 2017 for gross mortgage rate of 3.25, so those are now in the -- in the upper teens, so it is kind of flip flop, you think that -- I don't disagree with your thesis. .

Okay and Robert you have a defined about a billion a quarter, are you still able to do that and in say two to three year season to kind of paper?.

Yes, the first quarter was very interesting, everything spreads tightened dramatically early in the year, banks weren't buying, there was very little new production, the street did not have much inventory, there was very little selling, it is not uncommon for banks to come in early in the quarter.

Well, the spreads tightened and then you started to see a pick-up in secondary selling; I've got to take an advantage of higher spreads and so short recess, for example, tightened in early in the year and then started widening out if you notice our marks, our short recess were actually down in the quarter.

And then on top of that you're starting to see a lot of out-month productions, mainly as a result of rate going up; there is more ARM productions now and so for instance in the out-months the bigger Tier-1 originators that for instance in five one's that we're selling $10 million to $20 million blocks are now selling $20 million to $35 million blocks.

So ARM production as a percentage of production is up right now, last number I saw is about 17% of new production, now that's all going into agency MPS, Jumbo's and everything else but net-to-net the absolute increase in rates has caused our production to go up.

Now the curve flattening is more recent phenomenon and so you could see it back down again but ARMs that are coming out now, new production or reflected the one we had about 125 basis points, between two's and tens, and that's coming out a little bit now.

So long answer to your question but there is plenty of supply right now between new issue and secondary sell..

Okay, great. Well, thanks for the comments guys..

Sure..

[Operator Instructions] The next question comes from Bose George with KBW, please go ahead..

Hey, good morning guys. It is Eric [ph] on for Bose. What is the average loan age now of your current reset ARM portfolio. And do you suspect that going forward there will be any difference in the prepaid behavior of super season posts reset versus so called newer cohorts of post reset. .

Hi, Eric, this is Phil. We don't really break down the average age of the portfolio, we did get some months to role, month to reset average month to reset about six months as little as it has been for quite some time on our current resent, classified loans, all those loan resets that inside of 18 months.

And about 20-22 months -- about 40-41 months for longer rests and 22 overall for the portfolio. .

Yes, I know you guys look at the different cohorts and right now for instance ARMs that are resetting's for the first time, that are five or six years old [indiscernible]. Some of those are ramping up to north of 40 CPR, very season not -- a product that is 15 years old is still running around 20 CPR.

So there's a huge variants in speeds depending upon the age whether I O different attributes like that. I would just kind of say generically short resets are trending in the mid upper 20s and depending upon how much of the book is concentrated in newer versus season production that's going to be year lower or higher..

Can you share your current thoughts on what the fed might do next year. How is that factoring into your investment allocation. .

I'm sorry Eric, what was your question again..

What the fed's going to do next year, how many times are going to rise next year. What your current expectations for that. .

The curves called for a couple more bombs this year..

Yes, I think it's probably next year. I think long future involved for term of -- two in a quarter; I think the fed dots imply a term of funds rate of three; it's been pretty transparent it seems like they are signaling two moves this year, who knows what they are going to do next year.

But we really don't try to make a prediction when we're on executing our strategy, we think our strategy works very well in the environment where the feds moving gradually, and if you get some steepness in the curve it tends to go back out in the high twos, then you get a couple of fed moves, that is not bad for us..

Okay. Then one more for me. Can you tell us what the ROE is on the preferred equity that you guys have, I can calculate it pretty easily across the entire portfolio but what are the pre expense ROEs on the -- on the capital used from preferred..

Well, the cost to that capital to us is about seven and three quarters..

What the ROE though on capital use for investments on that. .

That's the margin of investing close to 10% right now. .

Okay. All right guys, thanks, thanks for the comments, appreciate it. .

This concludes the question and answer session. I would like to turn the conference back over to Lindsay Crabbe for any closing remarks. .

Thank you for joining us today, if you have further question please give us a call, we look forward to speak with you next quarter..

The conference is now concluded, thank you for attending today's presentation, you may now disconnect..