Good day and welcome to the Capstead Mortgage Corporation First Quarter 2018 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 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 first quarter earnings conference call. The first quarter earnings release was issued yesterday, April 25th, and was 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 26, 2018. Details of the replay are included in yesterday's release. With me 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. 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 26, 2018. The company assumes no obligation to update any statement including any forward-looking statements made during this call. With that, I'll turn it over to Phil.

Good morning. Welcome, everyone. I'll make a few brief comments and then we'll open the call up for questions. Regarding our financial results for the first quarter, we reported earnings of $0.16, $0.03 lower than fourth quarter results, $0.02 for the earnings difference from last quarter's due to non-recurring $1.9 million tax refund recorded in December in connection with the tax reform with the remaining difference primarily resulted lower incentive comp related accruals in the fourth quarter. We declared and paid a $0.16 common dividend for the first quarter. Net interest margins were largely unchanged at $22.6 million and benefit the higher cash yields and lower mortgage prepayments largely offset higher borrowing rates and lower portfolio balances. Book value declined at relatively 1.5% or $0.15 a share to $10.10 and includes $0.06 of book value accretion from repurchasing 3.5% of our outstanding stock and a meaningful discount of book during the quarter. Lastly, operating cost for our internally managed agency only platform remained at industry leading levels. Regarding the operating environment, we've seen fairly pronounced increases in market interest rates thus far in 2018 with 10-year treasury rates reaching 2.94% on February 21st and move a 54 basis points since yearend before exceeding the 2.74% at quarter end. Less in the month in the quarter, the tenure has reached 3%. Shorter-term rates also moved higher during the first quarter with 12 months LIBOR up 65 basis points and with two-year treasury rates up 38 basis points, again with further increases post-quarter end. By virtue of our sole focus on holding short duration agency guaranteed ARM security, we posted a small but positive economic return for the first quarter. In comparison, we suspect other mortgage REITs with large holdings at fixed rate agency securities, including a number of residential credit mortgage REITs, we report negative economic returns for this challenging period due to portfolio driven declines in book value. With our stock price closing the first quarter unchanged at $8.65 per share, we posted a TSR in keeping with our dividend yield, exceeding TSRs achieved by two of our agency and residential credit peers. And since quarter end our stock prices rallied 26 points closed at 8.91 last night putting further distance between ourselves and our peers. With our near-term results, we continue to be driven by mortgage prepayment levels and the pace of future increases in short-term interest rates. Our investment strategy of cost effectively managing a leverage portfolio of short duration in agency guaranteed ARM securities allows us the opportunity to generate attractive risk adjusted returns over a long-term time horizon. With that, I'll open the call up to questions.

We will now begin the question and answer session. [Operator Instructions] Our first question will come from Eric Hagen from KBW. Please go ahead, sir.

Thank you. Good morning. So, you guys are obviously where of the regulatory crackdown on some servicers of VA mortgages and the expectation that's created for refinancing activity too expectedly slow from some of those servicers and those loans. So, I guess two questions. First, can you just give us a sense if possible just to break down of VA within your Ginnie bucket? And then the obvious follow-up to that is, do you expect slower speeds result in portion of the portfolio relative to where they had been possibly otherwise without the regulatory crackdown? Thanks.

Yes, sure Eric. We don't disclose that in our releases, but we're pretty much fine TBA type securities and if you look at the composition of those for the most part, I'd say it's probably about 70:30 mix FHA to VA. We have some originators out there. They're doing 100% VA pools and those are mainly and like 31 and we're really not buying many of those. So, I would suspect our portfolio probably mirrors the aggregate Ginnie numbers out there. So, I think it's probably around 30% VA. The second part of your question, we think that's a positive going forward, we're not really seeing any dramatic changes yet, but it's not only with Ginnie Mae cracking down on servicers, I think they've already for few of them from issuing multi-vendor securities, but also VA was like they are going to get some legislation through further prohibit the churning - I see things about how the borrowers going to have to reset is closing calls within a year and a half, they have to have a reduction in rates, it's definitely going to be a positive for our Ginnie ARM portfolio which is over 20% of our book.

Right. So, just put some numbers on it. I mean if we're talking, if 30% of - 20% of the portfolio, we're not talking about a huge number but, do you think you can drive about a CPR change relative to where it potentially would have been otherwise in the next quarter or two?

Yes, I think, I can see that happening.

Okay, great. Thanks for that color. My second question is on buying back shares and leverage. First, do you expect to issue a new repurchase authorization assuming you continue to buy back stock. And then as a follow-up to that, should we take similar in the 9 to 9.5 times leverage range to be a level that you're comfortable with running this portfolio or else being held equal?

That leverage levels reasonable place for us to be and we have $67 million remaining on this $100 million repurchase authorization. We don't have the market cap of $900 million or so. We can't repurchase shares all the way down. So, we'll be looking at what else we can do with the capital over the course of the year before we buy anything back going forward. Same way we treated in the past where we have some fairly finance discounts to [indiscernible] within our common stock in the last four or five months.

Okay, great. My last question is really just on duration and spread risk. I think we're pretty attune to the sensitivity of ARMs to interest rates plus you guys do a great job of telling us your estimate for duration of the portfolio, but how about mortgage spreads, I mean just tell the yield on an ARM relative to the spread on either well just benchmark interest rates, treasuries or swaps and how does that spread for ARMs, how sensitive is that to other computing mortgage products like fix third year fix?

If you look at on a hedge basis, it's very competitive. Obviously, the yields aren't as high as the fixed rate pass through, but I think we're looking at spreads somewhere on purchases that the margin of 65 to 75 basis points switch, it fairs off 8 or 9 times of returns in the 9 to 10 areas. I mean we're really not stretching, but if you look at swapped out hedge levels on 15-year pass through that's theoretically like swaps plus 25. So, it really depends up how much interest rate risk you're willing to take. And the snapshot of our market right now yields, you're probably looking at realistic speed somewhere between 275 on short paper up to call it 310 on new as you filed one. So, depending upon how much you hedge and so forth but, yes, that's where we're getting that 65 to 75 basis points spread. But obviously yields are lower than fixed rates path of those ARMs.

That was very helpful on the earnings front. I guess I really meant more on kind of book value sensitivity basis just the spread duration if you will. How sensitive is an ARM to…?

Short duration on our portfolio is probably a little over three, if you look at 30-year pass throughs now some of them we train was spread duration of round six. So, we are much less sensitive to spread lightening moves based on the spread duration of our portfolio. If you noticed our duration, our absolute duration went out a little bit, we're about 12 months now and our duration gap is one to around four months and part of that is by extension. Our portfolio maybe extended like a quarter of month, last quarter. And part of it is by design we're not as prone to actively hedge some purchases right now, given what short rates have done.

And the market dynamics really for a little more exposure on the longer-term fixed rate product that is held by the federal reserve with them backing out the market to where they are this year.

Yes, I know that's certainly true. All right, great. Thanks for the color guys.

Sure.

The next question is from Steve DeLaney from JMP Securities. Please go ahead, sir.

Hey, good morning, guys. Thanks for taking the question. So, I've spent a little bit of time with the model the last couple of days and really strikes me that sort of having to shift their focus more from what used to be more just a prepay speed story to more focusing on the resets and the pro forma cash yield, so a couple questions along that line. First, Robert I was wondering if from a rate forecast we're using 445 for the second quarter as an estimate of short ARM resets, is that a reasonable figure for your portfolio?

If you look at, we kind of walk through fully in-depth levels on page 11 of the release and so if you look at that we have a - as top portion, we have a net WAC of 315 and we show the fully index net WAC of 409 and so if you assume those adjust evenly over a 12 month cycle that on the short reset position that will give you about 22, 23 basis points a quarter and coupon increases. And then obviously the longer resets don't increase. So, I mean yeah - I mean it takes time to get there, but a fully index one-year LIBOR security right now is, yeah - not 445.

Okay, got it, and it's just obviously depends on whatever individual securities aren't going to maybe - we're using about an average of 170 over one-year LIBOR, but obviously certain securities special I guess Ginnie Mae's, and all have a lower index?

Yeah, I think that's pretty fair on the LIBOR piece and the Ginnies of 150 net margins and they are based on CMC LIBOR and what are you seeing right now is around 220. So…

We disclosed those margins right there on that table, we see average.

Right.

Various cohorts.

Okay, great, and I see the 168. So, going from there and you take that data and you look at the fact that 50% of your ARMs are going to reset over the next 12 months, so call it 12% a quarter, I mean that's in theory and I guess what I am - the hardest thing I am trying to deal with now is to get an idea of when a borrower based with a reset, what is the behavior pattern and how much of the theoretical 12% per quarter is actually rolling through the reset and how much is refining away. I was looking for some sort of an indication of what kind of dropout percentage, how should I adjust my 12% per quarter theoretical reset?

That's really hard to do....

I was hoping you could help me, because I was struggling with it.

Yeah, I mean just for color like on the April speed report that just came out fully index post reset securities increased generically about 5 CPR and then it went from roughly 18 to 23. So, you are starting to see some of the season post resets, they are resetting up to 5% which is rising line with where current 30-year rate. So, you are seeing a little shift up the prepay ramp on those and then of course the securities are going through reset for the first time that we're 51s, some of those are trending 55 or 60 at that first reset, but then once they get through that reset they drop down to about 30 CPR. So, kind of for our short reset book I think if you just took all the aggregates and look at generic speeds and kind of cancel that in the mid-20s I think you'd be pretty close and then our - the longer reset book those are probably going to beat that type of securities are probably going to prepay 15 to 18 area..

Okay, got it. I know we get the point now just I am thinking periodic caps, it's not something we've had to think about. But do you have any meaningful percentage of like 2013 vintage 51s that might be resetting but actually subject to 175 basis points periodic cap or are you seeing any of that as well work just given the sharp move in LIBOR.

No. not really. I mean as you think about it most of the newest 51 that are originated lately have 160 net margins. And so, if when your LIBOR at 275 plus 160 that gets you to 435. So those would have to be securities that started out coupon of 235 or lower to get cap out. And we really don't own that much as that paper. If you look at our way to average coupon, on our long reset book, it's 270 unchanged. So, we really don't have much of that periodic cap risk right now.

And if any great, speak to the Ginnie a little bit.

Yeah, I mean Ginnie are long resets are close to 3. So, they would move up to 4.5 and right now it'd be at like 4.75 so that got a little bit period end cap risk right now. And the Ginnie - that fits very well right now at this stage.

All right. It didn't sound like we have to worry too much about. And my last one maybe this is for Lance or Phil whether you want to take it. Compensation figure I think one of the reason we've been missed by a penny or so here in the first quarter is the $0.02 compensation in 1Q2018 and I noticed back in 1Q2017 it was just 1.1. so, help me understand that, I assume it may have something to do with timing of incentive comp accruals. But help me understand that number in the first quarter and maybe also let me give me some idea of what a good run-rate for total G&A would be going forward including comp. thank you.

This is Phil. I'll give Lance to pass on that since he's not --. He's not the one that missed the accrual for incentive comp in December 2017, that was on me. We had a large...

Like your honesty.

Yeah. We had a large accrual release in the first quarter of 2017 associated with the prior year. We were overly optimistic on how we were going to perform relative to our peers on some of our incentive metrics. And we have to take it back in. we showed that adjusted in various places in our reports. But it would be easy to miss if you just look at the income statements.

Yeah, and I forgotten that, so the $2 million which you're saying is more in line in last years was artificially low and in the quarter.

Exactly, and on the same token in the fourth quarter of last year we took some accrual off as well and that off to a quarter comp numbers artificially low as well.

Right. And then of course you had the expenses in the middle of the year et cetera. So, okay, while I may follow up with you offline and just talk a little bit about the run-rate going forward for total G&A.

Yeah, we're still leading the pack with the somewhere in the neighborhood of 100 basis points of operating expenses give or take.

Thanks for the comments.

All right.

[Operator Instructions]. Showing no further questions at this time. We'll conclude our question-and-answer session. I would like to turn the conference back over to Lindsey Crabbe for closing remarks.

Thanks again for joining us today. If you have further questions, please give us the 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 your lines.