Good morning and welcome to the Capstead Market Second Quarter 2020 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. Please go ahead..

Good morning. Thank you for attending Capstead's second quarter earnings conference call. The second quarter earnings releases issued yesterday July 29, 2020 is posted on our Web site at www.capstead.com under the Investor Relations tab. The link to this webcast is also in the Investor Relations section of our Web site.

An archive of this webcast and a replay of this call will be available through October 28, 2020. Details for the replay are included in yesterday's release.

On the call today are Phil Reinsch, President and Chief Executive Officer; Robert Spears, Executive Vice President and Chief Investment Officer; and Lance Phillips, Senior Vice President and Chief Financial Officer.

To support the health and wellbeing of our employees and community and address the risks associated with the global COVID-19 pandemic, we have implemented our business continuity plan that enables our employees to work remotely. As such, please be patient with us as we answer questions.

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.

In addition certain terms used in this call are non-GAAP financial measures reconciliations of which are provided in the company's earnings release and the company's work schedules which have been filed on Form 8-K with the SEC and may also be accessed through the company's Web site.

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 Web site. The information contained in this call is current only as of the date of this call, July 30, 2020.

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

Thank you, Lindsay. And thanks everyone for your interest in Capstead. After my remarks, Lance will give a recap of the second quarter and then we'll open the call up to questions. We're pleased to report excellent results for the current quarter. We out earned our $0.15 common dividend run rate by 20%.

Even with significantly lower portfolio balances and less leverage producing an annualized return on common equity of 10.8%. Common dividend itself was unchanged for three quarters now and our core earnings met or exceeded the dividend in each of these quarters.

We're likely the only mortgage REIT that can make that claim, given the market disruptions experienced in March. As importantly, our portfolio recovered strongly in value over the course of the second quarter, contributing the lion's share of a $0.72 increase in book value to 6.79 per common share.

This 11.9% increase together with the common dividends resulted in an economic return for the quarter of 14.3%, which we expect to be one of the best performances in the sector as well.

Making these returns more compelling, we anticipate that our common and preferred dividends for 2020 will be characterized as 100% return to capital, due in large part to reductions in our derivative positions last quarter.

Looking forward, we expect to continue adding to our short duration agency only portfolio in the coming quarters, provided risk adjusted returns remain attractive. With unhedged repo borrowing rates in and around 25 basis points currently and with swap rates as cycle lows.

We should continue to see lower borrowing rates in the coming quarters even as we absorb higher levels of mortgage prepayment. Longer term, the Fed has made it clear that they intend to remain very accommodating, as the country grapples with the uncertainties of the pandemic.

This means keeping longer term rates under control via Treasury and Fixed Rate Agency MBS purchases and short-term interest rates low. As the economy recovers, we would expect reduced support for longer term rates potentially allowing more steepness to the yield curve to the benefit of our business.

Wrapping up, we believe that our agency only short duration focus is serving as well. And we are well positioned to generate attractive returns at lower leverage levels than we have employed in the recent past. For investors seeking risk adjusted [indiscernible] return with a comparatively higher degree of safety from interest rate and credit risk.

We believe Capstead represents a compelling opportunity as difficult to find elsewhere in the market. With that, I'll turn the call over to Lance..

Thank you, Phil. We reported a GAAP net income of 22.7 million this quarter or $0.19 per diluted common share. Our core earnings were 21.9 million or $0.18 per diluted common share. Our core earnings excluding realized and unrealized losses on our portfolio related interest swap agreements.

We include a reconciliation of GAAP before earnings on Page 9 of our press release. As Phil mentioned, book value increased $0.72, or 11.9% per share during the second quarter ending at $6.79 per common share, primarily due to $0.67 in portfolio related increases in value.

Portfolio yield averaged 2.33% during the quarter, a decrease of 16 basis points from the 2.49%, we reported in the prior quarter. Yields declined primarily due to lower cash yield as a portion of our portfolio reset to lower prevailing interest rates and lower coupons on recent acquisitions.

Our portfolio related borrowing costs after adjusting for our hedging activities averaged 1.09% during the second quarter, 63 basis points lower than in the prior quarter, leading to a 48 basis point improvement in our net interest spreads.

The benefits of lower unhedged repo rates and lower fixed rates on our swap book were partially offset by the declines in the receive leg of these derivatives based on lower 3-month LIBOR and OIS rates. At June 30, the fixed pay rate on our swap book was 1.27% a decline of 17 basis points from rate in effect on March 31.

These lower fixed rates should benefit future earnings. With that, we will open the call up to questions..

[Operator Instructions] our first question comes from Jason Stewart at JonesTrading..

Nice work navigating a tough environment. I was hoping you could share your thoughts on mortgage credit availability and how you think it factors into model prepay speeds..

So one thing that's become pretty apparent is that the originators aren't having as much trouble closing loans, whether refis or not, is during this pandemic like folks were speculating all spring long. So prepays are running pretty hot now with mortgage rates fairly low. At the same time, underwriting standards are pretty tight.

And you do have folks that may be having trouble qualifying given their personal circumstances..

Got it. That makes sense. And it did you, if I missed it early on, please forgive me.

Did you share incremental ROE numbers? Where do you think the market is today?.

On purchases at the margin right now we're looking at kind of 10% tight returns on a levered basis, between 7.5x and 8x in short duration products that we're focusing on..

The next question is from Steven Delaney at JMP Securities..

On book value be despite about $0.20, you've got much better visibility into arms than we do, just curious, Robert, how you're seeing arms trend here, we're almost one month into the third quarter.

Have they been stable or trended higher? What are you seeing recently?.

They're trading very, very well Steve. There's a really strong bank bit out there for both new issues and season arms and so they continue to trade well.

And if you think about it, I mean, with the fixed rate universe price in an aggregate well more than one out of five arms in the [104s] [ph] are somewhat compelling to the banks in particular so they have continued to grind in as such into the quarter, both quarter end and supply sticking up which is a good thing, new issue supply and I think that's even helping more because arms can be kind of funny actually increased volume can improve liquidity.

And guys can buy paper in size. Feel very positive from standpoint valuations going forward..

So yeah, I'm just curious what you supply. I mean, gosh, given where new rates are, I think we were had fallen down to like 5% to 6% of the market.

Are you actually seeing new production, volume picking up in arms despite the low record low 30, 15 year rates?.

Yes, I mean, there's enough steepness in the curve where production is starting to increase and actually, second quarter new arm production doubled from the first and so we have new issues, [71s] [ph] are being originated with gross lags and opportunities as it goes to a lot of refinance rates, there are on no cost basis are still around 3.25 for fixed rate bonds.

And so the steepness in the yield curve definitely helps. And all time rates get this low, people don't try to reach for as low as yield as they can. So from that standpoint, we're very positive on new issue, secondary selling with a lot less in the second quarter, obviously, but we are way off [indiscernible] acquired bonds going forward..

Great. And I'm just looking at your swap book.

I mean, it's got trying to figure out, you're going to have faster speeds and I assume that Lance has probably already adjusted the lifetime assumption given the curve that exists today, so that you can't get any -- Fed can't go any lower on the short-end, right? So what seems to me that you're -- the improvement you've got to hope your swap run off helps offset some of the pressure on your spread that you see from the faster speeds.

So it looks like, you'd have 400 million run off here in the second half of this year averaging about 180 that obviously go as low as 25 basis points.

I'm looking at the schedule, the number that jumps out is 2.5 billion a year from now third quarter at 21 at 125 basis points, any thoughts about that? Maybe you've done some swap termination and already, but what are your thoughts about that specific swap position and whether you would trade out of that?.

Yes. I mean, we look at that on a regular basis and there's a decent probability that we could terminate some shorter duration swaps and go out the curve a little bit. Quite frankly, right now we're able to -- essentially everything about it on to your money cheaper than we can 30 day repo.

And so I think we're very, very cognizant of what's going on there. And there's a decent probability that we do some of that..

Yes. I mean, the four-year swap is the same, roughly the same as a two year swap. So I mean, you can -- you got a lot of flexibility it would seem there. And one final thing, just, [AMS] [ph] showing, roll downs, right around 2% on one year resets. Is that what you're saying? I guess it's a range more, probably like 190 to 210..

Yes. And if you just kind of think about our margins on our arms and when LIBOR at 50, you kind of get in the low 2 for short reset flow.

And the positive thing about that obviously, is coupon going lower, is slightly negative, but the positive is those guys resetting now, mortgages in the 2.5, two and three quarters area and so they're probably not going to be as primed to refi.

And we're seeing that on our book right now, the prepaid pressure that we're really seeing right now or on our newer issues [Technical Difficulty] comes from the last couple of years. Our shorter season book is presenting very, very well right now.

And so I think that trend is going to continue even a new issue 71, originates two years ago was 50 to 75 basis points in the money right now and it's got a clean credit. So I think that trend will continue for the next few months where we have better street performance out of our season short resets than we do our longer reset buttons..

Next question is from Eric Hagen with KBW..

It was the only mortgage REIT with a somewhat meaningful Ginnie portfolio. I feel like these thoughts could be really valuable on the pace of buyout activity as a result of higher delinquencies and its impact on prepaid speeds in your portfolio..

Sure. I mean last month -- sure, most people are aware of it as Ginnie space, saw a huge spike in speed across the board fixed rate arms and it was buyout-related and so we're kind of early in the process. The question on buyouts is, does it behoove with the servicer to buy out and they're looking at being able to resecuritize the loans potentially.

One thing that caught the spike I think was initially 90 days for parents loans could be bought out and immediately pre-pooled to CBA type collateral.

So I think a lot of people took advantage of that window to buyout as much as they could that they could immediately resecuritize going forward, they're going to have to hold on to that paper for six months.

So the decision isn't as easy and then you come down to banks that have a lot of capital, that may be more prone to buy out loans and then the non-bank originators that don't have as much capital may not want to buy out loans.

So buyouts definitely drove a big spike in speeds last month, but that could continue for another month or two but I think long-term ultimately Ginnie's will start slowing down right now it's pretty passive [indiscernible]. But we don't have as many Ginnie's as we used to do, we sold a decent chunk back in the first quarter.

But even bonds you can tell and you can look at the services that even some of the seed and stuff, you could pick out a couple of banks, for instance, that obviously had big delinquent buyout programs in place over the last couple of months, we think that will subside in the next few months though..

As most of your Ginnie portfolio serviced by banks or non-banks?.

Well, so the really seasoned paper back in the day well is the biggest component of season Ginnie, newer issues that have shifted more to the non-bank originators, that quickens the freedoms et cetera. And so really, the line of demarcation is kind of like if you go back loans originated more than six or seven years ago. It's primarily bank servicers.

The newer issue is primarily non-bank servicers..

That's really interesting color. Thank you for that..

If you look at our portfolio, we only we got 2% in agencies that are bank service, if you will, that are not pre-reset classification their seasons and then another 8% or so that's a longer reset newer issue, Ginnie's. Fairly not a component of portfolio these days..

That's really interesting. Thank you again for that though. That's interesting color.

One of your peers was just talking about the term premium for repo having flattened considerably over the last few months is, is the idea to keep rolling 30 day repo or could you put on some funding for the rest of the curve?.

Yes. You're almost like -- that's exactly correct. I mean, 30 day repo is pretty much the same 90 day repo with most of our lenders, and so on we are and it depends on the lender and what we're used to with their behavior and so forth. So we are doing more 90-day repo than we have in the past. We haven't really extended beyond that.

But if it becomes more favorable, we wouldn't have a problem going out beyond that 90 days at this point, it's been primarily 90 days, but we saw an odd to take it out further, we definitely would..

[Operator Instructions] Our next question is from Hal Granger at Great Quarter Research..

Thank you for taking my question. Congratulations on a strong increase in your book value of 11.9% during the quarter to $6.79.

Can you give us a sense of where your book value is now?.

It's fairly flat to quarter end at this juncture..

This concludes our question-and-answer session. I would like to turn the conference back over to management for 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 is now concluded. Thank you for attending today's presentation. You may now disconnect..