Good morning and welcome to the Capstead Mortgage Corporation’s Fourth Quarter 2014 Earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today’s presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Lindsey Crabbe. Please go ahead, ma’am.

Good morning. Thank you for attending Capstead’s fourth quarter earnings conference call. The fourth quarter earnings release was issued yesterday, January 28, 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 60 days. A replay of this call will be available through March 29. Details of this replay are included in yesterday’s release. With me today are 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, January 29. 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 fourth quarter earnings call. As usual, I’m joined by Robert Spears, our portfolio manager, and Phil Reinsch, our CFO. Everybody will be here for questions after a few opening remarks. A little brief history - 2014, as everybody recalls, the 10-year treasury began a little above 3%, and I think as a surprise to most we ended the year at 2.17, which with all the Fed tapering I don’t think any experts foresaw the extent of where the treasury would end the year. Yesterday, the open market committee stated relative to its monetary policy that it can be patient this year and that basically they’re saying that anything they do, when they do it, it’s going to be very much data-dependent. But they did continue to state--they did state the policy that they will continue to reinvest principal payments from their agency security holdings, so there still remains some degree of stimulus in some purchases, which in general have been about $15 million to $20 million a month, much less than what their previous purchases have been. So far this year, the 10-year treasury has averaged about 1.9%. It hit a low in mid-January about 1.70. I think as of right now, it’s about 1.75. The extent of this rally has surprised most experts and the direction of the 10-year from here is uncertain, considering the state of the world with deflation in Europe, China slowing, Japan devaluing. We have an improving unemployment picture in the U.S. and low inflation benefiting from crude oil prices below $50 a barrel. Now, I guess it’s below $45 a barrel this morning. Experts are again trying to figure out the direction these events will move our economy, and I think you can firmly put the Federal…

[Operator instructions] We have a question from Steve DeLaney from JMP Securities. Please go ahead.

Thank you. Good morning everyone.

Good morning, Steve.

So Andy, I think your closing comment there really summed it up. Who really knows where long-term rates are going to be three months, six months from now? So in that context of uncertainty, your dividend policy the last couple of years, the board has tried to be forward thinking and for each of the past two years has sort of set a stable dividend. It was $0.31 and 2013 and of course $0.34 last year. Given this uncertainty, do you think the board is going to take that similar approach in 2015 and try to listen to what you and Robert have to say about your outlook, and then just try to set it at a level that despite some ups and downs, you might be able to just maintain a stable dividend for the year? Is that sort of the approach you think they will take? Thanks.

I think that over the last couple of years, exactly as you said, I think our shareholders have rewarded us. I think our stock price has performed well. One of the reasons, I think is the stable dividend throughout the year--

Agreed.

We’re very cognizant of that for this year. This year is very different than most, and I guess part of the good news here from the standpoint is we still have six weeks until our dividend declaration, so based on data dependence, we’ll figure out a few things between now and the next six weeks. But that’s high on our list. I think you can never say precisely that--you know, guarantee that that’s going to happen, but we’re very much aware of that. We think our shareholders appreciate that, and it’s data dependent this year and we’ve got six weeks to help figure that out.

Yes, okay. Well, thank you for that. The slight drop, less than 1% in book and a little bit of gross, as you said, $190 million. Leverage trickled up just a little bit, approximately 8.6. What would you say kind of your cap would be there? I mean, if things tighten up a little bit, how much room would you say you would be comfortable having to the upside, given the short duration of your portfolio?

I’ll answer kind of at a higher level and then let Robert chime in. From the standpoint with our short duration portfolio and how it--you know, just looking at the change in book value quarter-over-quarter and such, we’re comfortable definitely continuing to run at this leverage level, and that’s plus or minus a bit. We’re not going to shoot the moon and increase leverage materially, but we’ll be in and around this range, probably plus or minus a quarter of a turn or so. With our portfolio, it makes a lot of sense. Robert, you want to add anything?

Yes, I think a lot of it depends upon, a, if there are attractive purchase opportunities out there; and b, we have to be cognizant of speeds and liquidity. So I think if you just put a range on it, I think we could run anywhere from 8 to 9 times; but I think right now given what we know about potential speed increases and so forth, I think we’ll be closer to 8.5.

Right, that’s helpful. Thanks for the comments.

You’re welcome.

Our next question is from Joel Houck from Wells Fargo. Please go ahead.

Good morning, guys. Thank you. I wanted to talk a little bit about how the business is managed for unexpected events, and I mean if you go back a year ago, all of Wall Street was calling for interest rates to move higher, 10-year to go to 3. We repeatedly hear comments about who knows where rates are going to go. It seems, at least to me anyway, that if you look at the rest of the world, the U.S. is not going to be able to decouple from the rest of the world in terms of interest rates; otherwise, the dollar is going to explode and we’re going to have all kinds of difficulties from an economic standpoint. So how if the 10-year follows suit this year, and we’re talking about a low-1 or perhaps even breaking 1% by the end of the year, how would Capstead manage the company in that environment?

Well, I don’t think--that’s obviously a potential scenario that could happen, and a 1% 10-year and funds not moving is not good for any mortgage investor obviously, because everybody has prepayment issues when that does occur. Having said that, the nature of our portfolio being in short duration securities, we have less spread duration risk than a fixed rate book, and we are more comfortable with that because our hedges don’t get as far out of whack, given the part of the curve we’re on. So obviously it would be painful for everybody, but I don’t think we would manage our book materially different than we’re doing right now.

Part of the read-through to that kind of scenario is what’s our economy doing in the U.S., what’s unemployment, what’s happening with all that. You end up with the economy shrivelling up probably to that extent, so from the standpoint of people’s ability to refinance and take advantage of rates, one, you’ve got to have mortgage rates move significantly lower in line with that, and that in today’s world is more of a question; and then people’s ability to afford that on another hand. So it’s not likely you’re going to see mortgage rates, 30-year mortgage rates well below 3 in that sort of environment. It just doesn’t seem reasonable from that standpoint, but from the standpoint of the plus or minus range from where we stand right now, none of the experts can figure out which direction things are going. I mean, it’s 1.75 on the 10-year today. In a week, it could be 2, it could be 1.5. But it doesn’t change the way--as Robert said, it doesn’t change the way we think about running our business, because we’re such short duration. We deal in the very short end of the curve, so we’re still comfortable running our business the way we always do consistently.

So just to add on, I hear you - who knows where it’s going to go, but under that scenario, what you’re saying is the mortgage basis would likely widen and therefore prepayment risk wouldn’t be as great as what perhaps peoples’ models would show in a sub-1% 10-year environment. Is that an accurate--?

Yes, absolutely. If you look at where we are right now, last time we were at this level roughly in the 10-year was early 2013, and if you look at where a 30-year no-cost refinance is right now, it’s closer to 3.75, whereas in that period it was closer to 3 3/8ths. Originator spreads have widened and mortgages in general just don’t trade that well, so right now I think most people would say if we hang in at these levels, the refinance wave shouldn’t be as great this time as it was in 2013. Now, obviously if you get down to 1% on the 10-year, that’s a totally different ballgame, and speeds will obviously be faster than they were in 2013. But there is a limit to how fast they will go, I think, so yes, I think mortgages would widen dramatically in that environment.

Okay, great. Thanks guys.

Which will make hedging of that type product more challenging in that sort of environment, which is why we stay really in the short end of the curve.

Absolutely.

Our next question comes from Lucy Webster from Compass Point. Please go ahead.

Hey, good morning. I was just hoping you could talk about maybe any recent changes in the shape of the yield curve and how, if at all, that shifted the return profile of your portfolio.

Well I mean, obviously as the long end rallies and mortgages become refinanced, more refinances, speeds pick up and so our carry is decreased in that environment. At the same time, since year-end our hedging costs have come down as well and purchases at the margin have widened, and so--I mean, we are finding bonds selectively to buy right now to take advantage of the shift that we’ve had since year-end.

Great, thank you.

And again, just as a reminder, if you would like to ask a question, please press star then one on your touchtone phone. Our next question is from Mike Widner from KBW. Please go ahead, sir.

Yes, good morning, guys. So refi speeds and CPRs, obviously, are going to be an issue or the concern, I think as you guys highlighted, in the next couple of quarters or the rest of the year. I was wondering if you could give us the breakdown of where your CPRs stand in the big bucket of the current reset arms versus the longer reset arms.

Well we don’t break that out, but if you just look at where we’ve been running, kind of in the high teens area, generically our season and short resets are prepaying roughly 10 CPRs slower than our newer issue longer resets. So if you kind of look at speeds in general, so we were at 17.6 in the fourth quarter. Our reg [ph], we’ve got one month of prints [ph] out, right, January, and generically I think arm speeds were up a little over 1 CPR. They should come down a little bit in February due to seasonal and so forth, and then pick back up in March. The latest rally really doesn’t show up until the second quarter, and we’re 30 days into this rally so we really don’t know where rates are going to be. But once again, if you look back at 2013 as kind of a proxy, early 2013, our portfolio kind of kicked up into the low 20’s; but having said that, back then a no-cost refinance was about 3/8ths in yield lower. So a long way to answer your question, but what we’ve seen is our season and short reset securities have a tendency to when they do go up, they really don’t go up much more than mid-teens. The longer resets are generally about 10 CPR or so faster than that.

I’m used to it by now, but it’s always a little surprising that the current reset stuff does tend to sustainably pay slower than--you know, as things get near the refi date, obviously, that’s when a lot of arm borrowers hit the refis. But just looking at the data over the last few months and looking back to early ’13 and late ’12, it tends to be the bigger spikes come in the longer reset stuff.

Yeah, a lot of that, too, if you just think about it, our short reset bucket is so seasoned, and these guys have had so many opportunities to refinance and they started out at a higher rate and they’ve come down. The hot portion, if you will, of our portfolio is going to be longer resets that were originated in the latter half of 2013 and 2014, and I think you can extrapolate that into the fixed rate market as well because those guys are solid from a credit standpoint. It’s the low-hanging fruit for originators. So you really don’t see originators going after 12-year-old, $80,000 seasoned arm much. They just don’t do it, and so because of the seasoning and the number of times they’ve had it, the opportunities they’ve had to refinance, it gets burned out, is what happens.

And Mike, if you go back a decade, your state of mind and what you’re thinking is spot-on. That’s what it used to be - the stuff, as it approaches the reset date, that thing would be on fire, prepaying and taking with generally what the shape of the yield curve had been at that point in time. With the yield curve where we’ve been stuck for the last--you know, we’re not far from getting to a decade, these people are taking advantage of the very low interest rates on their current reset. They’re annually resetting loans. That’s very positive in here, and they don’t see it changing anytime soon. So it’s a new paradigm relative to the way mortgagors react. It’s very different than what used to be.

So it’s interesting you bring up a decade ago, because that was--you know, coming up on a decade ago was sort of the last time we ended up with a completely flat yield curve, and at some point even slightly inverted yield curve, which I would think--I don’t have the refi data broken out from a decade ago, but that seems like the situation where you might actually see the guys that are in current reset arms get more active in refinancing, because I would imagine that--you know, right now I think the problem--not the problem, but the issue for most of them is that you’re not going to get a lower rate than what you’re currently reset at, with the set at zero and all the indices sort of being low. But if Fed tightens and LIBOR is higher, and one-year treasuries and pretty much very index that they reset off of moves up, at that point, do you end up with a place where you can refi and not pay any increment at all on your rate? So I guess maybe you already sort of answered this, but was it a little different a decade ago? Did you see in a flat yield environment the current reset arms would actually spike?

Yeah, a decade ago or more, you had--I mean, anybody and everybody with low doc, no doc type loans, anybody could refi at the drop of a hat. The capacity of the system to refinance everybody in the world, they were doing it. It was so much easier back in that day to refi and cash out, and today the regulatory side has become more stringent and the originators have cut back staff over the last couple of years significantly. So part of the reason why the rates today are even at the same treasury kind of level, no-cash refi is still much higher than what it had been last time we saw this. Part of that is capacity constraints within the system of originators. But it’s a decade ago. I think that it’s a completely different environment with our regulatory environment today for the ability for somebody to refi like what we saw a decade ago. So I don’t think you’ll see those type levels.

Going back to your original question, though, obviously at this point they don’t have rate incentive either. I mean, our gross WAP [ph] on our portfolio is 3.15, and so a lot of these guys have a 3% roughly mortgage rate and a 30-year no-cost is 3.75. So they really can’t--economically they're not incented to refinance. Obviously if you get an environment where their mortgage rate is higher than a 30-year fixed rate, what you’re talking about could happen.

Yeah, I wasn’t thinking so much getting higher than a 30-year fixed, but if you’re in a 7-1 arm or a 10-1 arm and then the Fed--let’s say the Fed, with good intentions as always, the Fed makes the curve flat by the long end staying at 1.70--you know, let’s say the long end comes down to 1.50 and the Fed takes the short end 1%, which I don’t think would be a shocker. It would seem to me you do run the possibility that you could refi into a brand-new 10-1 or 7-1 at, say, 3.75 and then your current mortgage would reset to 3.75, 3.5. So that’s the piece I worry about, is when you can refi a current reset arm because the Fed has tightened rates, can you refi into a new one basically and lower your rate. And we’ll see - there’s a lot of ifs, ands or buts in there, but that’s the reason I asked about a decade ago, because I wasn’t so much thinking housing boom cash-out refi, I was thinking after the Fed got done with its 17 rate hikes, we did have a slightly inverted curve, which I would think might have created that situation last time.

Yeah, that’s one of the more challenging environments for mortgage REITs in general.

Yes, it is. Hopefully we don’t get there, but we’re all wondering what’s going to happen. Anyway, thanks for the color and comments, as always.

You’re welcome.

Ladies and gentlemen, this will conclude our question and answer session. I would now 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 your lines.