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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 8-K/A

 

CURRENT REPORT

 

PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Date of Report (Date of earliest event reported): October 19, 2021

 

Franklin BSP Realty Trust, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

Maryland 000-55188 46-1406086
(State or other jurisdiction (Commission File Number) (I.R.S. Employer
of incorporation)    Identification No.) 

 

1345 Avenue of the Americas, Suite 32A

New York, New York 10105

(Address of principal executive offices, including zip code)

 

Registrant’s telephone number, including area code: (212) 588-6770

 

(Former name or former address, if changed since last report)

 

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2 below):

 

¨ Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

 

¨ Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

 

¨ Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

 

¨ Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Trading Symbol(s) Name of each exchange on which
registered
Common Stock, par value $0.01 per share FBRT New York Stock Exchange
7.50% Series E Cumulative Redeemable Preferred Stock, par value $0.01 per share FBRT PRE New York Stock Exchange

 

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (§230.405 of this chapter) or Rule 12b-2 of the Securities Exchange Act of 1934 (§240.12b-2 of this chapter)

 

Emerging growth company ¨

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

 

 

 

 

On October 21, 2021, Franklin BSP Realty Trust, Inc. (“FBRT”) filed a Current Report on Form 8-K with the U.S. Securities and Exchange Commission (the “SEC”) in connection with the consummation on October 19, 2021 (the “Closing Date”), of the transactions contemplated by that certain Agreement and Plan of Merger, dated as of July 25, 2021, as amended pursuant to that certain First Amendment to Agreement and Plan of Merger, dated as of September 22, 2021 (as amended, the “Merger Agreement”), by and among FBRT, Rodeo Sub I, LLC (“Merger Sub”), Capstead Mortgage Corporation (“Capstead”) and, solely for the purposes set forth therein, Benefit Street Partners L.L.C., FBRT’s external manager (“BSP”). Pursuant to the Merger Agreement, on the Closing Date, Capstead merged with and into Merger Sub, with Merger Sub continuing as the surviving company (the “Merger”). This Current Report on Form 8-K/A is being filed to amend the Form 8-K to provide the financial statements and pro forma financial information described below, in accordance with the requirements of Item 9.01 of Form 8-K.

  

Item 9.01. Financial Statements and Exhibits.

 

(a) Financial Statements of Businesses Acquired.

 

The required audited consolidated financial statements of Capstead as of December 31, 2020 and December 31, 2019 and for each of the years ended December 31, 2020, December 31, 2019 and December 31, 2018 are filed as Exhibit 99.1 and are incorporated herein by reference.

 

The required unaudited consolidated financial statements of Capstead as of September 30, 2021 and December 31, 2020 and for each of the nine months ended September 30, 2021 and September 30, 2020 are filed as Exhibit 99.2 and are incorporated herein by reference.

 

(b) Pro Forma Financial Information.

 

The required unaudited pro forma condensed combined financial information with respect to the Merger is filed as Exhibit 99.3 and incorporated herein by reference. 

 

(d) Exhibits.

 

    EXHIBIT INDEX
Exhibit
No.
  Description
   
2.1   Agreement and Plan of Merger, dated as of July 25, 2021, by and among Benefit Street Partners Realty Trust, Inc., Rodeo Sub I, LLC, Capstead Mortgage Corporation and Benefit Street Partners L.L.C. (incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K filed with the SEC on July 26, 2020).
     
2.2   First Amendment to Agreement and Plan of Merger, dated September 22, 2021, by and among Benefit Street Partners Realty Trust, Inc., Rodeo Sub I, LLC, Capstead Mortgage Corporation and Benefit Street Partners L.L.C. (incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K filed with the SEC on September 22, 2021)
     
23.1   Consent of Ernst & Young LLP
     
99.1   Audited consolidated financial statements of Capstead Mortgage Corporation as of December 31, 2020 and December 31, 2019 and for each of the years ended December 31, 2020, December 31, 2019 and December 31, 2018
     
99.2   Unaudited consolidated financial statements of Capstead Mortgage Corporation as of September 30, 2021 and December 31, 2020 and for each of the nine months ended September 30, 2021 and September 30, 2020
     
99.3   Unaudited pro forma condensed combined financial information of Franklin BSP Realty Trust, Inc. as of September 30, 2021 and for the nine months ended September 30, 2021 and year ended December 31, 2020
     
104.1   Cover Page Interactive Data File (embedded within the Inline XBRL document)

 

 

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. 

 

  FRANKLIN BSP REALTY TRUST, INC. 
     
     
  By: /s/ Jerome S. Baglien
  Name: Jerome S. Baglien
  Title: Chief Financial Officer and Treasurer

 

Date: November 11, 2021

 

 

 

Exhibit 23.1

 

Consent of Independent Registered Public Accounting Firm

 

 

We consent to the incorporation by reference in Registration Statement No. 333-186111 on Form S-3 of Franklin BSP Realty Trust, Inc. (f/k/a Benefit Street Partners Realty Trust, Inc.) of our report dated February 19, 2021, relating to the consolidated financial statements of Capstead Mortgage Corporation as of December 31, 2020 and 2019 and for each of the years ended December 31, 2020, December 31, 2019 and December 31, 2018 incorporated by reference in this Current Report on Form 8-K/A of Franklin BSP Realty Trust, Inc.

 

 

/s/ Ernst & Young LLP

 

Dallas, Texas

 

November 11, 2021

 

 

 

Exhibit 99.1

 

CAPSTEAD MORTGAGE CORPORATION

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Financial Statements

 

    Page
     
Report of Independent Registered Public Accounting Firm   2
     
Consolidated Balance Sheets at December 31, 2020 and December 31, 2019   4
     
Consolidated Statements of Operations for the years ended December 31, 2020, 2019 and 2018   5
     
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2020, 2019 and 2018   6
     
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2020, 2019 and 2018   7
     
Consolidated Statements of Cash Flows for the years ended December 31, 2020, 2019 and 2018   8
     
Notes to the Consolidated Financial Statements   9

 

All financial statement schedules are omitted because they are not applicable or the required information is included in the consolidated financial statements and notes thereto.

 

Financial statements of subsidiaries have been omitted as such entities do not individually or in the aggregate exceed the 20% threshold under either the investment or income tests applicable under the appropriate regulations for inclusion. The Company owned 100% of each of its subsidiaries.

 

 

 

 

Report of Independent Registered Public Accounting Firm

 

To the Shareholders and the Board of Directors of Capstead Mortgage Corporation

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of Capstead Mortgage Corporation (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), stockholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 19, 2021 expressed an unqualified opinion thereon.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

Critical Audit Matter

 

The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

 

2 

 

 

Residential mortgage investments – Debt Securities

 

Description of the Matter Residential mortgage investments totaled $7.94 billion at December 31, 2020, consisting of Agency Securities classified as available-for-sale. As explained in Note 2 and Note 8 of the consolidated financial statements, residential mortgage investments are carried at fair value at each reporting date with unrealized gains and losses reported as a separate component of Accumulated other comprehensive income (loss). Fair values are influenced by current and projected changes in interest rates, prepayment expectations, market liquidity conditions and other factors including consideration of recent trading activity for similar investments and pricing levels. Auditing the Company’s accounting for certain securities within its residential mortgage investments portfolio was complex due to the estimation uncertainty in determining the fair value as these securities, which represent 1.95% of the portfolio of Residential mortgage investments, tend to have higher uncertainty in prepayment expectations, less recent trading activity or variability in pricing levels.
   
How We Addressed the Matter in Our Audit

We evaluated and tested the design and operating effectiveness of controls addressing the identified risks related to the Company’s process used in determining the valuation of residential mortgage investments, including management’s review of available third-party pricing data. We also tested management’s controls over the completeness and accuracy of the data used in the valuation.

 

Our audit procedures included, among others, independently pricing a sample of these securities which involved internally developing fair value estimates using independently derived data for significant assumptions (e.g. prepayment rate and portfolio yield) to compare with management’s determined prices. We involved an internal valuation specialist and third-party data in our procedures. Additionally, we performed analytical procedures, which included a sensitivity analysis to understand the impact of a change in average fair value compared to management’s mark-to-market adjustment for these securities.

 

    /s/ ERNST & YOUNG, LLP
     
We have served as the Company’s auditor since 1985    
Dallas, Texas    
February 19, 2021    

 

3 

 

 

Consolidated Balance Sheets

 

(In thousands, except pledged and per share amounts)

 

    December 31  
    2020     2019  
Assets            
Residential mortgage investments ($7.71 and $10.83 billion pledged at December 31, 2020 and 2019, respectively)   $ 7,937,552     $ 11,220,630  
Cash collateral receivable from derivative counterparties     74,411       65,477  
Derivatives at fair value           1,471  
Cash and cash equivalents     257,180       105,397  
Receivables and other assets     136,107       127,026  
    $ 8,405,250     $ 11,520,001  
Liabilities                
Secured borrowings   $ 7,319,083     $ 10,274,498  
Derivatives at fair value     41,484       29,156  
Unsecured borrowings     98,493       98,392  
Common stock dividend payable     15,281       14,605  
Accounts payable and accrued expenses     20,746       29,617  
      7,495,087       10,446,268  
Stockholders’ equity                
Preferred stock - $0.10 par value; 100,000 shares authorized: 7.50% Cumulative Redeemable Preferred Stock, Series E, 10,329 shares issued and outstanding ($258,226 aggregate liquidation preference) at December 31, 2020 and 2019     250,946       250,946  
Common stock - $0.01 par value; 250,000 shares authorized: 96,481 and 94,606 shares issued and outstanding at December 31, 2020 and 2019, respectively     965       946  
Paid-in capital     1,268,439       1,252,481  
Accumulated deficit     (651,071 )     (444,039 )
Accumulated other comprehensive income     40,884       13,399  
      910,163       1,073,733  
    $ 8,405,250     $ 11,520,001  

 

 

See accompanying Notes to Consolidated Financial Statements.

 

4 

 

 

Consolidated Statements of Operations

 

(In thousands, except per share amounts)

 

    Year ended December 31  
    2020     2019     2018  
Interest income                        
Residential mortgage investments   $ 186,261     $ 320,109     $ 274,733  
Other     474       2,789       1,752  
      186,735       322,898       276,485  
Interest expense                        
Secured borrowings     (67,891 )     (246,140 )     (206,881 )
Unsecured borrowings     (7,620 )     (7,611 )     (7,611 )
      (75,511 )     (253,751 )     (214,492 )
Net interest income     111,224       69,147       61,993  
Other (expense) income:                        
Loss on derivative instruments (net)     (159,547 )     (90,578 )      
Loss on sale of investments (net)     (67,820 )     (1,365 )      
Compensation-related expense     (8,278 )     (8,197 )     (7,759 )
Other general and administrative expense     (5,011 )     (4,494 )     (4,527 )
Miscellaneous other (expense) revenue     (141 )     149       365  
      (240,797 )     (104,485 )     (11,921 )
Net (loss) income     (129,573 )     (35,338 )     50,072  
Less preferred stock dividends     (19,368 )     (19,368 )     (19,368 )
Net (loss) income available to common stockholders   $ (148,941 )   $ (54,706 )   $ 30,704  
                         
Basic and diluted net (loss) income per common share   $ (1.56 )   $ (0.62 )   $ 0.34  

 

 

See accompanying Notes to Consolidated Financial Statements.

 

5 

 

 

Consolidated Statements of Comprehensive Income (Loss)

 

(In thousands)

 

    Year ended December 31  
    2020     2019     2018  
Net (loss) income   $ (129,573 )   $ (35,338 )   $ 50,072  
Other comprehensive income (loss)                        
Amounts related to available-for-sale securities:                        
Change in net unrealized gain or loss     (27,580 )     71,148       (72,490 )
Reclassification adjustment for amounts included in net (loss) income     66,864       1,365        
Amounts related to cash flow hedges:                        
Change in net unrealized gain or loss     (15,621 )     (17,080 )     25,716  
Reclassification adjustment for amounts included in net (loss) income     3,822       (20,988 )     (36,390 )
      27,485       34,445       (83,164 )
Comprehensive loss   $ (102,088 )   $ (893 )   $ (33,092 )

 

 

See accompanying Notes to Consolidated Financial Statements.

 

6 

 

 

Consolidated Statements of Stockholders’ Equity

 

(In thousands, except per share amounts)

 

    Preferred
Stock
    Common
Stock
    Paid-in
Capital
    Accumulated
Deficit
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Stockholders’
Equity
 
Balance at December 31, 2017     250,946       957       1,271,425       (346,570 )     62,118       1,238,876  
Net income                       50,072             50,072  
Change in unrealized gain on mortgage securities, net                             (72,490 )     (72,490 )
Amounts related to cash flow hedges, net                             (10,674 )     (10,674 )
Cash dividends:                                                
Common – $0.49 per share                 (13,759 )     (30,704 )           (44,463 )
Preferred – $1.875 per share                       (19,368 )           (19,368 )
Common stock repurchases           (107 )     (84,487 )                 (84,594 )
Other additions to capital           3       1,701                   1,704  
Balance at December 31, 2018     250,946       853       1,174,880       (346,570 )     (21,046 )     1,059,063  
Net loss                       (35,338 )           (35,338 )
Change in unrealized gain on mortgage securities, net                             72,513       72,513  
Amounts related to cash flow hedges, net                             (38,068 )     (38,068 )
Cash dividends:                                                
Common – $0.47 per share                       (42,763 )           (42,763 )
Preferred – $1.875 per share                       (19,368 )           (19,368 )
Issuance of common stock           90       75,012                   75,102  
Other additions to capital           3       2,589                   2,592  
Balance at December 31, 2019   $ 250,946     $ 946     $ 1,252,481     $ (444,039 )   $ 13,399     $ 1,073,733  
Net loss                       (129,573 )           (129,573 )
Change in unrealized gain on mortgage securities, net                             39,284       39,284  
Amounts related to cash flow hedges, net                             (11,799 )     (11,799 )
Cash dividends:                                                
Common – $0.60 per share                       (58,091 )           (58,091 )
Preferred – $1.875 per share                       (19,368 )           (19,368 )
Issuance of common stock           16       12,841                   12,857  
Other additions to capital           3       3,117                   3,120  
Balance at December 31, 2020   $ 250,946     $ 965     $ 1,268,439     $ (651,071 )   $ 40,884     $ 910,163  

 

 

See accompanying Notes to Consolidated Financial Statements.

 

7 

 

 

Consolidated Statements of Cash Flows

 

(In thousands)

    Year ended December 31  
    2020     2019     2018  
Operating activities:                        
Net (loss) income   $ (129,573 )   $ (35,338 )   $ 50,072  
Adjustments to reconcile net (loss) income to cash provided by operating activities:                        
Amortization of investment premiums     77,560       73,740       115,333  
Amortization of equity-based awards     3,234       2,724       1,783  
Amortization of unrealized loss (gain) on de-designated hedges     529       (14,712 )      
Loss on sale of mortgage investments     67,820       1,365        
Loss on derivative instruments (net)     142,483       112,834        
Other depreciation and amortization     124       110       110  
Net change in receivables, other assets, accounts payable and accrued expenses     (3,834 )     14,331       (2,102 )
Net cash provided by operating activities     158,343       155,054       165,196  
Investing activities:                        
Purchases of residential mortgage investments     (3,173,342 )     (3,316,158 )     (2,302,656 )
Proceeds from sales of residential mortgage investments     2,558,871       303,991        
Interest receivable acquired with the purchase of residential mortgage investments     (5,024 )     (6,422 )     (4,476 )
Principal collections on residential mortgage investments, including changes in mortgage securities principal remittance receivable     3,772,086       3,751,570       3,607,459  
Redemption of lending counterparty investment           5,000        
Net cash provided by investing activities     3,152,591       737,981       1,300,327  
Financing activities:                        
Proceeds from repurchase arrangements and similar borrowings     82,969,163       138,721,910       173,854,358  
Principal payments on repurchase arrangements and similar borrowings     (85,924,578 )     (139,425,767 )     (175,205,622 )
(Increase) decrease in cash collateral receivable from interest rate swap counterparties     (8,934 )     (33,680 )     10,709  
Net payments on interest rate swap settlements     (130,793 )     (130,802 )     (8,734 )
Common stock repurchases                 (84,594 )
Issuance of common stock     12,882       75,195        
Other capital stock transactions     (108 )     (106 )     (72 )
Dividends paid     (76,783 )     (54,677 )     (75,186 )
Net cash used in financing activities     (3,159,151 )     (847,927 )     (1,509,141 )
Net change in cash and cash equivalents     151,783       45,108       (43,618 )
Cash and cash equivalents at beginning of year     105,397       60,289       103,907  
Cash and cash equivalents at end of year   $ 257,180     $ 105,397     $ 60,289  

 

 

See accompanying Notes to Consolidated Financial Statements.

 

8 

 

 

Notes to Consolidated Financial Statements

 

NOTE 1 — BUSINESS

 

Capstead Mortgage Corporation operates as a self-managed real estate investment trust for federal income tax purposes (a “REIT”) and is based in Dallas, Texas. Unless the context otherwise indicates, Capstead Mortgage Corporation, together with its subsidiaries, is referred to as “Capstead” or the “Company.” Capstead earns income from investing in a leveraged portfolio of residential mortgage pass-through securities currently consisting primarily of adjustable-rate mortgage (“ARM”) securities issued and guaranteed by government-sponsored enterprises, either Fannie Mae, Freddie Mac, or by an agency of the federal government, Ginnie Mae. Together, these securities are referred to as “Agency Securities” and are considered to have limited, if any, credit risk.

 

NOTE 2 — ACCOUNTING POLICIES

 

Basis of Presentation

 

The consolidated financial statements include the accounts of Capstead Mortgage Corporation and its wholly-owned and majority-owned subsidiaries over which it exercises control. Pursuant to variable interest entity (“VIE”) accounting principles, Capstead considers for consolidation any VIE in which it holds an interest. Intercompany balances and transactions are eliminated.

 

Recent Accounting Pronouncements

 

In June 2016, Accounting Standards Update No. 2016-13, Financial Instruments – Credit Losses (“ASU 2016-13”) was issued which replaced the incurred loss impairment methodology in previous GAAP with a methodology that is designed to better reflect expected credit losses. For financial instruments carried at amortized cost, impairment is measured as a current estimate of expected lifetime credit losses. For available-for-sale debt securities in which changes in fair value are recorded in accumulated other comprehensive income, the write-down of available-for-sale securities under the “other-than-temporarily” impaired model was replaced with an allowance for credit losses model. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. The Company adopted ASU 2016-13 on January 1, 2020 which had no material effect on the Company’s results of operations, financial condition and cash flows primarily due to the limited, if any, credit risk of Agency Securities.

 

Use of Estimates

 

Fair values of nearly all financial instruments held by the Company are estimated based on a market approach using available market information and appropriate valuation methodologies (Level Two Inputs); however, judgment is required in interpreting market data to develop these estimates. Fair values fluctuate on a daily basis and are influenced by changes in, and market expectations for changes in, interest rates, market liquidity conditions and levels of mortgage prepayments, as well as other factors. Accordingly, estimates of fair value are as of the balance sheet dates and are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and estimation methodologies may have a material effect on estimated fair values. Judgment is also exercised in making impairment conclusions and estimating impairment charges.

 

Amortization of investment premiums on financial assets is based in part on estimates of future levels of mortgage prepayments. Estimates are influenced by changes in, and market expectations for changes in, interest rates, market liquidity conditions, actual levels of mortgage prepayments and other factors. Judgment is required in developing these estimates, however the actual level of mortgage prepayments for a given accounting period is the single largest determinant in amortizing investment premiums.

 

9 

 

 

Cash and Cash Equivalents

 

Cash and cash equivalents include unrestricted cash on hand and highly liquid investments with original maturities of three months or less when purchased.

 

Financial Assets

 

Capstead’s financial assets consist of Agency Securities classified as available-for-sale and carried at fair value with net unrealized gains and losses reported as a separate component of Accumulated other comprehensive income. Interest is recorded as income when earned. Investment premiums and discounts are recognized as adjustments to interest income by the interest method over the expected life of the related financial assets. Realized gains and losses from any financial asset sales are recorded as a component of Other (expense) income. The specific identification method is used to determine the cost of financial assets sold. Financial assets are reviewed for potential impairment at each balance sheet date. Impairments of investments in mortgage securities can occur with changes in the Company’s intent or ability to hold the mortgage securities until any declines in fair value are recovered and as a result of adverse changes in the financial condition of the issuer(s) such that a full recovery of cost basis is no longer expected. The amount of any such impairment is measured by comparing the recorded amount of the security to its fair value. If the decline in fair value is credit-related, an allowance for credit losses would be recognized in earnings as a component of Other (expense) income. If it was determined to be more likely than not that the Company will incur a loss via an asset sale, the difference between amortized cost and fair value would be recognized in earnings as a component of Other (expense) income.

 

Borrowings

 

Secured borrowings in the form of repurchase arrangements create exposure to the potential for failure on the part of counterparties to honor their commitment to return pledged collateral. In the event of a default by a repurchase arrangement counterparty, the Company may have difficulty recovering its collateral. To mitigate this risk, the Company monitors the creditworthiness of its counterparties and manages its exposure to any single counterparty.

 

Capstead’s borrowings are carried at their principal balances outstanding net of related debt issuance costs and debt discounts, if applicable. Debt issuance costs associated with Unsecured borrowings are recognized as adjustments to interest expense by the interest method over the term of these borrowings.

 

Derivative Financial Instruments (“Derivatives”)

 

Derivatives used by Capstead for risk management purposes are carried at fair value as assets or liabilities. The accounting for changes in fair value of Derivatives held depends on whether it has been designated as a hedge for accounting purposes, as well as the type of hedging relationship identified. Capstead may designate any Derivatives held as cash flow hedges related to a designated portion of its current and anticipated future borrowings. To qualify as a cash flow hedge, at the inception of the hedge relationship the Company must document that the hedge relationship is anticipated to be highly effective and monitor ongoing effectiveness on at least a quarterly basis. As long as the hedge relationship remains effective, the change in fair value of the Derivatives are recorded in Accumulated other comprehensive income. Changes in fair value of Derivatives not held as accounting hedges, if any, or for which the hedge relationship is no longer considered highly effective, are recorded in earnings as a component of Other (expense) income. On March 1, 2019 the Company discontinued its use of hedge accounting on its interest rate swaps related to Secured borrowings, while retaining hedge accounting for swaps related to Unsecured borrowings.

 

The Company uses Derivatives primarily in the form of interest rate swap agreements to hedge the variability in borrowing rates on its secured and unsecured borrowings. If designated as accounting hedges, related fixed interest payments and variable interest receipts are recorded as an adjustment to interest expense on the related designated borrowings. If not designated as accounting hedges, fixed interest payments and variable interest receipts are recorded as a component of Other (expense) income. For Derivatives initially designated as accounting hedges and subsequently de-designated, unrealized gain or loss included in Accumulated other comprehensive income at the time of de-designation is amortized as an adjustment to interest expense on the related borrowings over the remaining term of the Derivatives.

 

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Derivatives create exposure to credit risk related to the potential for failure on the part of counterparties to honor their commitments. In addition, the Company is required to post collateral primarily based on any declines in the market value of the Derivatives. In the event of default by a counterparty, the Company may have difficulty recovering its collateral and may not receive payments provided for under the terms of the Derivatives. Pursuant to regulatory changes implemented in 2013, most Derivatives held at December 31, 2020 were entered into through Derivative exchanges established in part to mitigate credit risk.

 

Cash collateral receivable from derivative counterparties, when present, represents cash remitted to swap counterparties to meet initial and ongoing margin requirements that are based on the fair value of these Derivatives, including related interest receivable or payable under the terms of the agreements. The Company may also remit mortgage securities to certain of its swap counterparties to meet ongoing margin requirements. Such mortgage securities, if any, are included in Residential mortgage investments. Similarly, Cash collateral payable to derivative counterparties, when present, represents cash received from counterparties to meet margin call requirements. For presentation purposes, the Company does not offset individual counterparty collateral receivables (or payables) with the recorded fair value of related interest rate swap agreements pursuant to master netting arrangements. In addition, gross unrealized gains on Derivatives (recorded as assets) are stated separately from gross unrealized losses (recorded as liabilities) without regard to counterparty. Certain cash margin amounts are presented on a net basis against the fair value of related Derivatives.

 

Long-term Incentive Compensation

 

Capstead provides its employees and its directors with long-term incentive compensation in the form of equity-based awards. Equity-based compensation costs are initially measured at the estimated fair value of the awards on the grant date developed using appropriate valuation methodologies. Valuation methodologies used and subsequent expense recognition is dependent upon each award’s service and performance conditions, the latter also referred to as performance metrics. Capstead has elected not to estimate future award forfeitures when valuing equity-based awards and adjusts compensation costs as actual forfeitures occur.

 

Compensation costs for equity-based awards subject only to service conditions are measured at the closing stock price on the dates of grant and are recognized as expense on a straight-line basis over the requisite service periods for the awards, as adjusted for any forfeitures. Compensation costs for components of equity-based awards subject to nonmarket-based performance metrics (i.e. metrics not predicated on changes in the Company’s stock price), are measured at the closing stock price on the dates of grant, adjusted for the probability of achieving benchmarks included in the performance metrics. These initial cost estimates are recognized as expense over the requisite performance periods, adjusted for subsequent changes in performance estimates. Compensation costs for components of equity-based awards subject to market-based performance metrics are measured at the dates of grant using Monte Carlo simulations which incorporate into the valuations the inherent uncertainty regarding achieving the market-based performance metrics. These initial valuation amounts are recognized as expense over the requisite performance periods, subject to adjustments only for actual forfeitures.

 

Income Taxes

 

Capstead Mortgage Corporation and its qualified REIT subsidiaries have elected to be taxed as a REIT. As a result, Capstead is not taxed on taxable income distributed to stockholders if certain REIT qualification tests are met. Capstead’s policy is to distribute 100% of its taxable income, after application of available tax attributes, within the time limits prescribed by the Internal Revenue Code (the “Code”), which may extend into the subsequent taxable year. The Company may find it advantageous from time to time to elect taxable REIT subsidiary status for certain of its subsidiaries in which case taxable income of any such subsidiary would be subject to federal and, where applicable, state or local income taxes. Any such income taxes are accounted for using the liability method. Related deferred income tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company has not recognized any liabilities for unrecognized tax benefits using a “more likely than not” threshold for the recognition and measurement of the financial statement effects of tax positions taken on a tax return filing. Should any such liabilities be recognized in future periods, the Company will record related interest and penalties in Other general and administrative expense.

 

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Dividend Classification

 

The tax and financial reporting classification of dividends can differ primarily as a result of differences between taxable income attributable to a particular tax year and that year’s Net income (loss), the amount and timing of dividends paid relative to taxable income and how such taxable income is allocated to dividends paid.

 

NOTE 3 — NET INCOME (LOSS) PER COMMON SHARE

 

Basic net income (loss) per common share is computed by dividing net (loss) income, after deducting dividends paid or accrued on preferred stock and allocating earnings to equity awards deemed to be participating securities pursuant to the two-class method, by the average number of shares of common stock outstanding, calculated excluding unvested stock awards. Participating securities include unvested equity awards that contain non-forfeitable rights to dividends prior to vesting.

 

Diluted net income (loss) per common share is computed by dividing the numerator used to compute basic net income (loss) per common share by the denominator used to compute basic net income (loss) per common share, further adjusted for the dilutive effect, if any, of equity awards and shares of preferred stock when and if convertible into shares of common stock. Shares of the Company’s 7.50% Series E Cumulative Redeemable Preferred Stock are contingently convertible into shares of common stock only upon the occurrence of a change in control and subject to the conditions set forth in our charter and therefore are not considered dilutive securities absent such an occurrence. Any unvested equity awards that are deemed participating securities are included in the calculation of diluted net income (loss) per common share, if dilutive, under either the two-class method or the treasury stock method, depending upon which method produces the more dilutive result. The following table illustrates the computation of basic and diluted net income (loss) per common share for the indicated periods (dollars in thousands, except per share amounts).

 

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    Year ended December 31  
    2020     2019     2018  
Basic net income (loss) per common share                        
Numerator for basic net income (loss) per common share:                        
Net (loss) income   $ (129,573 )   $ (35,338 )   $ 50,072  
Preferred stock dividends     (19,368 )     (19,368 )     (19,368 )
Earnings participation of unvested equity awards     (137 )     (100 )     (102 )
    $ (149,078 )   $ (54,806 )   $ 30,602  
Denominator for basic net income (loss) per common share:                        
Average number of shares of common stock outstanding     96,242       89,349       91,565  
Average unvested stock awards outstanding     (750 )     (627 )     (451 )
      95,492       88,722       91,114  
                         
    $ (1.56 )   $ (0.62 )   $ 0.34  
Diluted net income (loss) per common share                        
Numerator for basic net income (loss) per common share   $ (149,078 )   $ (54,806 )   $ 30,602  
                         
Denominator for basic net income (loss) per common share     95,492       88,722       91,114  
Net effect of dilutive equity awards     -       -       116  
      95,492       88,722       91,230  
                         
    $ (1.56 )   $ (0.62 )   $ 0.34  

 

Anti-dilutive securities that could be potentially dilutive in the future that were not included in the computation of diluted net income (loss) per common share include equity awards for 902,000 and 947,000 shares of common stock excludable under the treasury stock method for years ended December 31, 2020 and 2019, respectively. There were no potentially dilutive securities excluded from the computation of year ended December 31, 2018.

 

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NOTE 4 — RESIDENTIAL MORTGAGE INVESTMENTS

 

Residential mortgage investments classified by collateral type and interest rate characteristics were as follows as of the indicated dates (dollars in thousands):

 

    Unpaid
Principal
Balance
    Investment
Premiums
    Amortized
Cost Basis
    Carrying
Amount (a)
    Net
WAC
 (b)
    Average
Yield (b)
 
December 31, 2020                                                
Agency Securities:                                                
Fannie Mae/Freddie Mac ARMs   $ 6,982,650     $ 252,921     $ 7,235,571     $ 7,310,089       2.67 %     2.14 %
Ginnie Mae ARMs     599,726       17,704       617,430       627,463       3.39       1.80  
    $ 7,582,376     $ 270,625     $ 7,853,001     $ 7,937,552       2.73       2.10  
                                                 
December 31, 2019                                                
Agency Securities:                                                
Fannie Mae/Freddie Mac ARMs   $ 8,628,739     $ 262,293     $ 8,891,032     $ 8,931,872       3.45 %     2.72 %
Ginnie Mae ARMs     2,214,447       69,884       2,284,331       2,288,758       3.53       2.85  
    $ 10,843,186     $ 332,177     $ 11,175,363     $ 11,220,630       3.46       2.75  

 

(a) Includes unrealized gains and losses for residential mortgage investments classified as available-for-sale.

 

(b) Net WAC, or weighted average coupon, is the weighted average interest rate of the mortgage loans underlying the indicated investments net of servicing and other fees as of the indicated balance sheet date. Net WAC is expressed as a percentage calculated on an annualized basis on the unpaid principal balances of the mortgage loans underlying these investments.

 

(c) Average yield is presented for the year then ended,and is based on the cash component of interest income expressed as a percentage on average amortized cost basis (the “cash yield”) less the effects of amortizing investment premiums. Investment premium amortization is determined using the interest method and incorporates actual and anticipated future mortgage prepayments.

 

Agency Securities are considered to have limited, if any, credit risk because the timely payment of principal and interest is guaranteed. The maturity of Agency Securities is directly affected by prepayments of principal on the underlying mortgage loans. Consequently, actual maturities will be significantly shorter than the portfolio’s weighted average contractual maturity of 292 months.

 

Capstead’s ARM Agency Securities are backed by residential mortgage loans that have coupon interest rates that adjust at least annually to more current interest rates or begin doing so after an initial fixed-rate period. After the initial fixed-rate period, if applicable, mortgage loans underlying ARM securities typically either (i) adjust annually based on specified margins over the one-year London interbank offered rate (“LIBOR”) or the one-year Constant Maturity U.S. Treasury Note Rate (“CMT”), (ii) adjust semiannually based on specified margins over six-month LIBOR, or (iii) adjust monthly based on specified margins over indices such as one-month LIBOR, the Eleventh District Federal Reserve Bank Cost of Funds Index, or over a rolling twelve month average of the one-year CMT index, usually subject to periodic and lifetime limits, or caps, on the amount of such adjustments during any single interest rate adjustment period and over the contractual term of the underlying loans.

 

Capstead classifies its ARM investments based on average number of months until coupon reset (“months to roll”). Months to roll is an indicator of asset duration which is a measure of market price sensitivity to interest rate movements. A shorter duration generally indicates less interest rate risk. Current-reset ARM investments have months to roll of less than 18 months while longer-to-reset ARM investments have months to roll of 18 months or greater. As of December 31, 2020, the average months to roll for the Company’s $2.9 billion (amortized cost basis) in current-reset ARM investments was 6.3 months while the average months to roll for the Company’s $5.0 billion (amortized cost basis) in longer-to-reset ARM investments was 56.2 months.

 

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During 2020 and 2019, the Company sold available-for-sale securities using the specific identification method for proceeds totaling $2.56 billion and $304.7 million recognizing zero and $405,000 in gross realized gains and $67.8 million and $1.8 million in gross realized losses. The Company did not sell any securities during 2018.

 

NOTE 5 — SECURED BORROWINGS

 

Capstead pledges its Residential mortgage investments as collateral for secured borrowings primarily in the form of repurchase arrangements with commercial banks and other financial institutions. Repurchase arrangements entered into by the Company involve the sale and a simultaneous agreement to repurchase the transferred assets at a future date and are accounted for as financings. The Company maintains the beneficial interest in the specific securities pledged during the term of each repurchase arrangement and receives the related principal and interest payments.

 

The terms and conditions of secured borrowings are negotiated on a transaction-by-transaction basis when each such borrowing is initiated or renewed. The amount borrowed is generally equal to the fair value of the securities pledged, as determined by the lending counterparty, less an agreed-upon discount, referred to as a “haircut.” Interest rates are generally fixed based on prevailing rates corresponding to the terms of the borrowings. Interest may be paid monthly or at the termination of a borrowing at which time the Company may enter into a new borrowing at prevailing haircuts and rates with the same lending counterparty or repay that counterparty and negotiate financing with a different lending counterparty. None of the Company’s lending counterparties are obligated to renew or otherwise enter into new borrowings at the conclusion of existing borrowings. In response to declines in fair value of pledged securities due to changes in market conditions or the publishing of monthly security pay-down factors, lending counterparties typically require the Company to post additional securities as collateral, pay down borrowings or fund cash margin accounts with the counterparties in order to re-establish the agreed-upon collateral requirements. These actions are referred to as margin calls. Conversely, in response to increases in fair value of pledged securities, the Company routinely margin calls its lending counterparties in order to have previously pledged collateral returned.

 

15 

 

 

Secured borrowings (and related pledged collateral, including accrued interest receivable), classified by collateral type and remaining maturities, and related weighted average borrowing rates as of the indicated dates were as follows (dollars in thousands): 

 

Collateral Type   Collateral
Carrying
Amount
    Accrued
Interest
Receivable
    Borrowings
Outstanding
    Average
Borrowing

Rates
 
December 31, 2020                                
Borrowings under repurchase arrangements
secured by Agency securities with
maturities of 30 days or less
  $ 5,249,989     $ 12,597     $ 4,972,181       0.21 %
Borrowings under repurchase arrangements
secured by Agency securities with
maturities of 31 to 90 days
    1,939,034       4,225       1,846,902       0.20  
Borrowings under repurchase arrangements
secured by Agency securities with
maturities greater than 90 days
    522,969       1,167       500,000       0.29  
    $ 7,711,992     $ 17,989     $ 7,319,083       0.21  
                                 
December 31, 2019                                
Borrowings under repurchase arrangements
secured by Agency securities with
maturities of 30 days or less
  $ 9,484,275     $ 27,826     $ 9,002,527       2.12 %
Borrowings under repurchase arrangements
secured by Agency securities with
maturities of 31 to 90 days
    1,344,437       3,742       1,271,971       1.98  
    $ 10,828,712     $ 31,568     $ 10,274,498       2.10  

 

Average secured borrowings outstanding were $8.21 billion and $10.8 billion during 2020 and 2019, respectively. Average secured borrowings outstanding differed from respective year-end balances during the indicated periods primarily due to changes in portfolio levels and differences in the timing of portfolio acquisitions relative to portfolio runoff and asset sales. Interest paid on Secured borrowings, including related Derivative cash flows, totaled $105.0 million, $232.2 million, $213.7 million and million during 2020, 2019, and 2018, respectively.

 

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NOTE 6 — USE OF DERIVATIVES, OFFSETTING DISCLOSURES AND CHANGES IN OTHER COMPREHENSIVE INCOME BY COMPONENT

 

Capstead’s portfolio of Derivatives hedge the variability of the underlying benchmark interest rate of current and forecasted 30- to 90-day secured borrowings. The Company attempts to mitigate exposure to higher interest rates primarily by entering into pay-fixed, receive-variable, interest rate swap agreements for terms between eighteen months and three years. From an economic perspective, this hedge relationship establishes a relatively stable fixed rate on related borrowings because the variable-rate payments received on the swap agreements offset a significant portion of the interest accruing on the borrowings, leaving the fixed-rate swap payments as the Company’s effective borrowing rate, subject to certain adjustments. Additionally, changes in fair value of these Derivatives tend to offset opposing changes in fair value of the Company’s residential mortgage investments that can occur in response to changes in market interest rates.

 

The Company discontinued hedge accounting in March 2019 for its secured borrowings-related interest rate swaps and, for GAAP purposes, related changes in fair value are recorded in the Company’s consolidated statements of operations beginning on the de-designation date. Also, for GAAP purposes related net unrealized gains recorded in Accumulated other comprehensive income through the de-designation date are being recognized as a component of interest expense in the Company’s consolidated statements of operations over the contractual terms of these swaps.

 

During 2020 Capstead entered into swap agreements with notional amounts totaling $5.77 billion requiring fixed-rate interest payments averaging 0.57% for periods between eighteen months and three years commencing on various dates between January 2020 and December 2020. During 2020, $800 million notional amount of swaps requiring fixed-rate interest payments averaging 2.20% matured. The Company also terminated $9.40 billion notional amount of swaps requiring fixed-rate interest payments averaging 1.54% during 2020. At December 31, 2020, the Company’s portfolio financing-related swap positions, all of which were either SOFR- or OIS-indexed, had the following characteristics (dollars in thousands):

 

Period of Contract Expiration   Swap Notional
Amounts
    Average Fixed
Rates
 
Second quarter 2022   $ 400,000       0.02 %
Third quarter 2022     1,200,000       0.01  
Fourth quarter 2022     900,000       0.07  
Third quarter 2023     100,000       0.03  
Fourth quarter 2023     374,500       0.09  
    $ 2,974,500          

 

The Company has three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements with notional amounts totaling $100 million and average fixed rates of 4.09% with 20-year payment terms coinciding with the floating-rate terms of the Company’s Unsecured borrowings that mature in 2035 and 2036. These Derivatives, which are designated as cash flow hedges for accounting purposes, hedge the variability of the underlying benchmark interest rate associated with the floating-rate terms of these long-term borrowings. These Derivatives’ LIBOR-indexed receive rates match the underlying floating-rate terms of the Company’s Unsecured borrowings and therefore the eventual replacement of the LIBOR index on these Derivatives is not expected to have any financial impact.

 

Interest rate swap agreements are measured at fair value on a recurring basis primarily using Level Two Inputs in accordance with ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820). In determining fair value estimates for swaps, Capstead utilizes the standard methodology of netting the discounted future fixed cash payments and the discounted future variable cash receipts which are based on expected future interest rates derived from observable market interest rate curves. Eurodollar futures are measured at fair value using Level 1 inputs based on quoted exchange prices on these contracts. The Company also incorporates both its own nonperformance risk and its counterparties’ nonperformance risk in determining fair value. In considering the effect of nonperformance risk, the Company considered the impact of netting and credit enhancements, such as collateral postings and guarantees, and has concluded that counterparty risk is not significant to the overall valuation.

 

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The fair value of exchange-traded swap agreements hedging Secured borrowings is calculated including accrued interest and net of variation margin amounts received or paid through the exchange, resulting in separately presenting on the balance sheet a fair value amount representing the unsettled fair value of these Derivatives. Non-exchange traded swap agreements held as cash flow hedges of Unsecured borrowings are reported at fair value calculated excluding accrued interest. At December 31, 2020, Cash collateral receivable from derivative counterparties includes initial margin for all Derivatives and variation margin for non-exchange traded Derivatives. Accrued interest for non-exchange traded swap agreements is included in Accounts payable and accrued expenses.

 

The following tables include fair value and other related disclosures regarding all Derivatives held as of and for the indicated periods (in thousands):

 

    Balance Sheet   December 31  
    Location   2020     2019  
Balance sheet-related                    
Swap agreements in a gain position (an asset) related to secured borrowings   (a)   $     $ 733  
Eurodollar futures contracts in a gain position   (a)           738  
Swap agreements in a loss position (a liability) related to unsecured borrowings   (a)     (41,484 )     (29,156 )
Related net interest payable   (b)     (597 )     (437 )
        $ (42,081 )   $ (28,122 )

 

(a) The fair value of Derivatives with unrealized gains are aggregated and recorded as an asset on the face of the Balance Sheets separately from the fair value of Derivatives with unrealized losses that are recorded as a liability.

 

(b) Included in “Accounts payable and accrued expenses” on the face of the Balance Sheets.

 

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    Location of
Gain or (Loss)

Recognized in
  Year ended December 31  
    Net (Loss) Income   2020     2019     2018  
Income statement-related                            
Components of Secured borrowings-related effects on interest expense:                            
Amount of gain reclassified from Accumulated other comprehensive income       $     $ 7,891     $ 38,292  
Amount of unrealized gain, net of unrealized losses on de-designated Derivatives         (529 )     14,712        
    (a)     (529 )     22,603       38,292  
Component of Unsecured borrowings-related effects on interest expense:                            
Amount of loss reclassified from Accumulated other comprehensive income   (b)     (3,293 )     (1,616 )     (1,902 )
(Increase) decrease in interest expense as a result of the use of Derivatives       $ (3,822 )   $ 20,987     $ 36,390  
                             
Realized and unrealized (loss) gain on non-designated Derivatives (net) related to:                            
Interest rate swap agreements       $ (156,748 )   $ (91,791 )   $  
Eurodollar futures         (2,799 )     1,213        
    (c)   $ (159,547 )   $ (90,578 )   $  
                             
Other comprehensive income-related                            
Amount of (loss) gain recognized in Other comprehensive income (loss)       $ (15,621 )   $ (17,080 )   $ 25,716  

 

(a) Included in “Interest expense: Secured borrowings” on the face of the Statements of Operations.

 

(b) Included in “Interest expense: Unsecured borrowings” on the face of the Statements of Operations.

 

(c) Included in “Loss on derivative instruments (net)” on the face of the Statement of Operations.

 

Capstead’s swap agreements and borrowings under repurchase arrangements are subject to master netting arrangements in the event of default on, or termination of, any one contract. See NOTE 5 for more information on the Company’s use of secured borrowings. The following tables provide further details concerning offsetting of financial liabilities and Derivatives as of the indicated dates (in thousands):

 

    Offsetting of Derivative Assets  
          Gross     Net Amounts     Gross Amounts Not Offset        
    Gross     Amounts     of Assets     in the Balance Sheet (b)        
    Amounts of     Offset in     Presented in           Cash        
    Recognized     the Balance     the Balance     Financial     Collateral     Net  
    Assets (a)     Sheet (a)     Sheet     Instruments     Received     Amount  
December 31, 2020                                    
Counterparty 4   $ 2,673     $ (2,673 )   $     $     $     $  
December 31, 2019                                                
Counterparty 4   $ 6,517     $ (5,046 )   $ 1,471     $     $     $ 1,471  

 

(a) Included in gross amounts of recognized assets at December 31, 2020 is the fair value of exchange-traded swap agreements, calculated including accrued interest. Included in gross amounts offset in the balance sheet are variation margin amounts associated with these swaps at December 31, 2020.

 

(b) Amounts presented are limited to recognized liabilities and cash collateral received associated with the indicated counterparty sufficient to reduce the related Net Amount to zero in accordance with ASU No. 2011-11, as amended by ASU No. 2013-01.

 

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    Offsetting of Financial Liabilities and Derivative Liabilities  
          Gross     Net Amounts     Gross Amounts Not Offset        
    Gross     Amounts     of Liabilities     in the Balance Sheet (c)        
    Amounts of     Offset in     Presented in           Cash        
    Recognized     the Balance     the Balance     Financial     Collateral     Net  
    Liabilities(a)     Sheet (a)     Sheet (b)     Instruments     Pledged     Amount  
December 31, 2020                                    
Derivatives by counterparty:                                                
Counterparty 1   $ 42,082     $     $ 42,082     $     $ (42,082 )   $  
Counterparty 4     257       (257 )                        
      42,339       (257 )     42,082             (42,082 )      
Borrowings under repurchase arrangements (d)     7,320,090             7,320,090       (7,320,090 )            
    $ 7,362,429     $ (257 )   $ 7,362,172     $ (7,320,090 )   $ (42,082 )   $  
December 31, 2019                                                
Derivatives by counterparty:                                                
Counterparty 1   $ 29,593     $     $ 29,593     $     $ (29,593 )   $  
Counterparty 4     21,601       (21,601 )                        
      51,194       (21,601 )     29,593             (29,593 )      
Borrowings under repurchase arrangements (d)     10,286,011             10,286,011       (10,286,011 )            
    $ 10,337,205     $ (21,601 )   $ 10,315,604     $ (10,286,011 )   $ (29,593 )   $  

 

(a) Included in gross amounts of recognized liabilities at December 31, 2020 is the fair value of non-exchange traded swap agreements (Counterparty 1) and exchange-traded swap agreements (Counterparty 4), calculated including accrued interest. Included in gross amounts offset in the balance sheet are variation margin amounts associated with exchange-traded swap agreements at December 31, 2020.

 

(b) Amounts presented are limited to recognized liabilities and cash collateral received associated with the indicated counterparty sufficient to reduce the related Net Amount to zero in accordance with ASU No. 2011-11, as amended by ASU No. 2013-01.

 

(c) Amounts presented are limited to recognized assets and collateral pledged associated with the indicated counterparty sufficient to reduce the related Net Amount to zero in accordance with ASU No. 2011-11, as amended by ASU No. 2013-01.

 

(d) Amounts include accrued interest payable of $1.0 million and $11.5 million on borrowings under repurchases arrangements as of December 31, 2020 and December 31, 2019, respectively.

 

The amount of unrealized losses, net of unrealized gains, included in Accumulated other comprehensive income scheduled to be recognized in the Statements of Operations over the next twelve months primarily in the form of fixed-rate swap payments in excess of current market rates on swaps related to unsecured borrowings and amortization of net unrealized losses on de-designated interest rate swaps totaled $6.1 million at December 31, 2020. Changes in Accumulated other comprehensive income by component for the three years ended December 31, 2020 were as follows (in thousands):

 

20 

 

 

    Unrealized
Gains and Losses

on Cash Flow
Hedges
    Unrealized Gains
and Losses on
Available-for-Sale
Securities
    Total  
Balance at December 31, 2017   $ 16,874     $ 45,244     $ 62,118  
Activity for the year ended December 31, 2018:                        
Other comprehensive income (loss) before reclassifications     25,716       (72,490 )     (46,774 )
Amounts reclassified from accumulated other comprehensive income     (36,390 )           (36,390 )
Other comprehensive loss     (10,674 )     (72,490 )     (83,164 )
Balance at December 31, 2018     6,200       (27,246 )     (21,046 )
Activity for the year ended December 31, 2019:                        
Other comprehensive (loss) income before reclassifications     (17,080 )     71,148       54,068  
Amounts reclassified from accumulated other comprehensive income     (20,988 )     1,365       (19,623 )
Other comprehensive (loss) income     (38,068 )     72,513       34,445  
Balance at December 31, 2019     (31,868 )     45,267       13,399  
Activity for the year ended December 31, 2020:                        
Other comprehensive loss before reclassifications     (15,621 )     (27,580 )     (43,201 )
Amounts reclassified from accumulated other comprehensive income     3,822       66,864       70,686  
Other comprehensive (loss) income     (11,799 )     39,284       27,485  
Balance at December 31, 2020   $ (43,667 )   $ 84,551     $ 40,884  

 

NOTE 7 — UNSECURED BORROWINGS

 

Unsecured borrowings consist of 30-year junior subordinated notes issued in 2005 and 2006 and maturing in 2035 and 2036, for a total face amount of $100 million. Note balances net of deferred issuance costs, and related weighted average interest rates as of the indicated dates (calculated including issuance cost amortization and adjusted for the effects of related Derivatives held as cash flow hedges) were as follows (dollars in thousands):

 

    December 31, 2020     December 31, 2019  
    Borrowings
Outstanding
    Average
Rate
    Borrowings
Outstanding
    Average
Rate
 
Junior subordinated notes maturing in:                                
October 2035 ($35,000 face amount)   $ 34,431       7.87 %   $ 34,392       7.88 %
December 2035 ($40,000 face amount)     39,435       7.64       39,397       7.64  
September 2036 ($25,000 face amount)     24,627       7.68       24,603       7.68  
    $ 98,493       7.73     $ 98,392       7.73  

 

The notes are currently redeemable, in whole or in part, without penalty, at the Company’s option. Interest paid on Unsecured borrowings, including related Derivative cash flows, totaled $7.5 million during 2020, 2019 and 2018, respectively.

 

21 

 

 

NOTE 8 — FAIR VALUES OF FINANCIAL INSTRUMENTS

 

The fair value of Capstead’s financial assets and liabilities are influenced by changes in, and market expectations for changes in, interest rates and market liquidity conditions, as well as other factors beyond the control of management. With the exception of the fair value of Eurodollar futures, all fair values were determined using Level 2 Inputs in accordance with ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820). Eurodollar futures are Derivatives for which Level 1 inputs are used to determine fair value.

 

Residential mortgage investments, all of which are mortgage securities classified as available-for-sale, are measured at fair value on a recurring basis. In determining fair value estimates the Company considers recent trading activity for similar investments and pricing levels indicated by lenders in connection with designating collateral for secured borrowings, provided such pricing levels are considered indicative of actual market clearing transactions. The Company currently bases fair value for Unsecured borrowings on discounted cash flows using Company estimates for market yields. Excluded from these disclosures are financial instruments for which cost basis is deemed to approximate fair value due primarily to the short duration of these instruments, which are valued using primarily Level 1 measurements, including Cash and cash equivalents, Cash collateral receivable from derivative counterparties, receivables, payables and Secured borrowings with initial terms of 120 days or less. See NOTE 6 for information relative to the valuation of interest rate swap agreements.

 

The following table presents the fair value for the Company’s financial instruments as of the indicated dates (in thousands):

 

        December 31, 2020     December 31, 2019  
    Fair
Value
Hierarchy
  Carrying
Amount
    Fair
Value
    Carrying
Amount
    Fair
Value
 
Financial assets:                                    
Secured borrowings-related interest rate swap agreements   Level 2   $     $     $ 733     $ 733  
Eurodollar futures   Level 1                 738       738  
Financial liabilities:                                    
Secured borrowings with initial terms of greater than 120 days   Level 2     500,000       500,100              
Unsecured borrowings   Level 2     98,493       59,900       98,392       68,100  
Unsecured borrowings-related interest rate swap agreements   Level 2     41,484       41,484       29,156       29,156  
                                     

Fair value-related disclosures for debt securities were as follows as of the indicated dates (in thousands):

 

    Amortized     Gross Unrealized        
    Cost Basis     Gains     Losses     Fair Value  
December 31, 2020                        
Agency Securities classified as available-for-sale:                        
Fannie Mae/Freddie Mac   $ 7,235,571     $ 87,158     $ 12,640     $ 7,310,089  
Ginnie Mae     617,430       10,541       508       627,463  
December 31, 2019                                
Agency Securities classified as available-for-sale:                                
Fannie Mae/Freddie Mac     8,890,949       64,593       23,753       8,931,789  
Ginnie Mae     2,284,331       11,560       7,133       2,288,758  

 

22 

 

 

    December 31, 2020     December 31, 2019  
    Fair
Value
    Unrealized
Loss
    Fair
Value
    Unrealized
Loss
 
Securities in an unrealized loss position of one year or greater:                        
Fannie Mae/Freddie Mac   $ 690,227     $ 9,533     $ 2,030,192     $ 17,069  
Ginnie Mae     27,462       285       560,022       5,775  
Securities in an unrealized loss position of less than one year:                                
Fannie Mae/Freddie Mac     583,870       3,107       1,473,144       6,684  
Ginnie Mae     41,527       223       416,888       1,358  
    $ 1,343,086     $ 13,148     $ 4,480,246     $ 30,886  

 

From a credit risk perspective, federal government support for Fannie Mae and Freddie Mac helps ensure that fluctuations in value are due to interest rate changes and are not due to credit risk associated with these securities. The unrealized losses on the Company’s investment in Agency Securities were caused by interest rate changes, and the contractual cash flows of those investments are guaranteed by an agency of the U.S. government. The Company does not intend to sell the investments as of December 31, 2020 and it is not more likely than not that the Company will be required to sell the investments before recovering their related amortized cost bases.

 

NOTE 9 — INCOME TAXES

 

Capstead and a subsidiary for which the Company has elected taxable REIT subsidiary status file separate tax returns in U.S. federal and state jurisdictions, where applicable. Provided Capstead remains qualified as a REIT and all its taxable income is distributed to stockholders within allowable time limits, no income taxes are due on this income. Accordingly, no provision has been made for income taxes for Capstead. Taxable income, if any, of the Company’s largely dormant taxable REIT subsidiary is fully taxable and provision is made for any resulting income taxes. The Company is no longer subject to examination and the related assessment of tax by federal, state, or local tax authorities for years before 2017.

 

For tax years after 2017, the Tax Cuts and Jobs Act (“Tax Act”) repealed the corporate Alternative Minimum Tax (“AMT”). AMT credit carryforwards became fully utilizable without limitation or, in the absence of regular tax liability, fully refundable over the ensuing four years. Accordingly, in 2017 the Company’s taxable REIT subsidiary recognized a refund of AMT under the Tax Act and recorded a receivable in Receivables and other assets, which was collected in full in 2020 under the provisions of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) of 2020.

 

Additionally, the CARES Act modified the rules for REIT net operating losses (“NOL”). A REIT NOL carryover can now only offset 80% of taxable income for losses arising in years beginning after December 31, 2020. The 80% limitation is calculated by multiplying current-year REIT taxable income before the dividends paid deduction by 80%. For tax years beginning before January 1, 2021, a taxpayer can offset 100% of its income in any given year with an NOL. Although there will be an annual NOL limitation for tax years starting after December 31, 2020, the Tax Act allows post-2017 NOLs to be carried forward indefinitely. At December 31, 2020 Capstead had an NOL of $90 million that does not expire.

 

23 

 

 

The Company’s effective tax rate differs substantially from statutory federal income tax rates primarily due to the benefit of Capstead’s status as a REIT, along with other items affecting the Company’s effective tax rate as illustrated below for the indicated periods (in thousands):

 

    Year ended December 31  
    2020     2019     2018  
Income taxes computed at the federal statutory rate   $ 2     $ 6     $ 10,515  
Benefit of REIT status                 (10,512 )
Income taxes computed on income of the Company's taxable REIT subsidiary     2       6       3  
Other change in net deferred income tax assets     (2 )     (6 )     (3 )
Income tax (benefit) provision recorded in miscellaneous other revenue (expense)   $     $     $  

 

No income taxes were paid during 2020, 2019 or 2018. Capstead had $17.5 million in net capital loss carryforwards that expired at the end of 2019. At December 31, 2020 Capstead has $68.2 million in net capital loss carryforwards that if unused, expire at the end of 2025. Significant components of the Company’s taxable REIT subsidiary’s deferred income tax assets and liabilities were as follows as of the indicated dates (in thousands):

 

    December 31  
    2020     2019  
Deferred income tax assets:                
Net operating loss carryforwards (a)   $ 71     $ 24  
Other     9       10  
      80       34  
Deferred income tax liabilities            
Net deferred tax assets   $ 80     $ 34  
Valuation allowance (b)   $ 80     $ 34  

 

(a) The increase in net operating loss carryforward from 2019 to 2020 is due to a carryforward correction noted in reconciliation against filed tax returns.

 

(b) Because this subsidiary is not expected to earn significant amounts of taxable income, related net deferred tax assets are fully reserved at December 31, 2020.

 

NOTE 10 — STOCKHOLDERS’ EQUITY

 

In February 2020, the Company issued 1.6 million shares of common stock through an at-the-market continuous offering program at an average price of $8.21, net of fees and other costs, for net proceeds of $12.9 million. On August 1, 2019 the Company completed a public offering for nine million shares of common stock raising $75.1 million at a net price of $8.34 per share after underwriting discounts and offering expenses. The proceeds were deployed into additional ARM Agency Securities and used for general corporate purposes. Additional amounts of equity capital may be raised in the future under continuous offering programs or by other means, subject to market conditions, compliance with federal securities laws and blackout periods.

 

In 2019 Capstead’s Board of Directors increased its 2017 common stock repurchase program authorization to $125 million, leaving a remaining repurchase program authorization of approximately $37 million. The Company did not repurchase shares in 2020 or 2019. During 2018, the Company repurchased 10.7 million shares for an average net repurchase price of $7.94 for a total capital deployment of $84.6 million.

 

During 2020, 2019 and 2018, additions to common equity capital related to equity-based awards to directors and employees totaled $3.1 million, $2.6 million and $1.7 million, respectively. See NOTE 11 for further information pertaining to long-term equity-based awards.

 

24 

 

 

At December 31, 2020 and 2019, the Company had issued and outstanding 10.3 million shares of its 7.50% Series E Cumulative Redeemable Preferred Stock. Shares of the Series E preferred stock are redeemable at the Company’s option for $25.00 per share, plus any accumulated and unpaid dividends and have a liquidation preference of $25.00 per share. The Company issued no Series E preferred stock in 2020, 2019 or 2018.  

 

NOTE 11 — EQUITY INCENTIVE PLAN

 

All equity-based awards and other long-term incentive awards are made pursuant to the Company’s Amended and Restated 2014 Flexible Incentive Plan that was approved by stockholders in May 2014. At December 31, 2020, this plan had 2,454,061 shares of common stock remaining available for future issuances.

 

Long-term equity-based Awards – Performance-based Restricted Stock Units (“RSUs”)

 

A summary of the Company’s restricted stock unit activity and related information for the year ended December 31, 2020 is summarized below:

 

          Weighted  
          Average  
    Number of     Grant Date  
    Shares     Fair Value  
Unvested RSU awards outstanding at December 31, 2019     538,945     $ 8.50  
Grants     191,314       8.03  
Forfeitures     (148,894 )     10.52  
Unvested RSU awards outstanding at December 31, 2020     581,365       7.83  

 

Dividends accrue from the date of grant and will be paid in cash to the extent the units convert into shares of common stock following completion of related performance periods. Unrecognized estimated compensation expense for these awards totaled $1.3 million at December 31, 2020, to be expensed over a weighted average period of 1.4 years (assumes estimated attainment levels for the related performance metrics will be met).

 

Recognized in Compensation-related expense are $932,000, $771,000 and $104,000 related to this program during 2020, 2019 and 2018, respectively. Included in Common stock dividends payable at December 31, 2020 and 2019 are estimated dividends payable pertaining to these awards of $354,000 and $125,000, respectively.

 

Long-term equity-based Awards – Stock Awards

 

Stock award activity for the year ended December 31, 2020 is summarized below: 

 

          Weighted  
          Average  
    Number of     Grant Date  
    Shares     Fair Value  
Unvested stock awards outstanding at December 31, 2019     615,045     $ 8.14  
Grants     322,744       7.39  
Vestings     (169,748 )     9.98  
Unvested stock awards outstanding at December 31, 2020     768,041       7.42  

 

During 2020, 2019 and 2018, the Company recognized in Compensation-related expense $1.7 million, $1.4 million and $1.2 million, respectively, related to amortization of the grant date fair value of employee stock awards. In addition, the Company recognized in Other general and administrative expense $570,000, $505,000 and $450,000 related to amortization of the grant date fair value of director stock awards during 2020, 2019 and 2018, respectively. Unrecognized compensation expense for unvested stock awards totaled $2.1 million as of December 31, 2020, to be expensed over a weighted average period of 1.3 years.

 

Service-based stock awards issued to directors and to non-executive employees receive dividends on a current basis without risk of forfeiture if the related awards do not vest. Stock awards issued to executives defer the payment of dividends accruing between the grant dates and the end of related performance or service periods. If these awards do not vest, the related accrued dividends will be forfeited. Included in Common stock dividend payable at December 31, 2020 and 2019 are estimated dividends payable pertaining to these awards totaling $533,000 and $350,000, respectively.

 

25 

 

Exhibit 99.2

 

CAPSTEAD MORTGAGE CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except pledged and per share amounts)

 

    September 30, 2021     December 31, 2020  
      (unaudited)          
Assets                
Residential mortgage investments ($6.77 and $7.71 billion pledged at September 30, 2021 and December 31, 2020, respectively)   $ 7,134,106     $ 7,937,552  
Cash collateral receivable from derivative counterparties     68,533       74,411  
Cash and cash equivalents     125,174       257,180  
Receivables and other assets     136,182       136,107  
    $ 7,463,995     $ 8,405,250  
Liabilities                
Secured borrowings   $ 6,463,964     $ 7,319,083  
Derivatives at fair value     31,191       41,484  
Unsecured borrowings     98,569       98,493  
Common stock dividend payable     7,920       15,281  
Accounts payable and accrued expenses     20,096       20,746  
      6,621,740       7,495,087  
Stockholders’ equity                
Preferred stock - $0.10 par value; 100,000 shares authorized: 7.50% Cumulative Redeemable Preferred Stock, Series E, 10,329 shares issued and outstanding ($258,226 aggregate liquidation preference) at September 30, 2021 and December 31, 2020     250,946       250,946  
Common stock - $0.01 par value; 250,000 shares authorized: 96,876 and 96,481 shares issued and outstanding at September 30, 2021 and December 31, 2020, respectively     969       965  
Paid-in capital     1,270,497       1,268,439  
Accumulated deficit     (656,920 )     (651,071 )
Accumulated other comprehensive income     (23,237 )     40,884  
      842,255       910,163  
    $ 7,463,995     $ 8,405,250  

 

 

See accompanying notes to consolidated financial statements.

 

 

 

CAPSTEAD MORTGAGE CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

    Quarter Ended     Nine Months Ended  
    September 30     September 30  
    2021     2020     2021     2020  
Interest income                                
Residential mortgage investments   $ 19,662     $ 37,571     $ 66,603     $ 154,890  
Other     14       26       39       457  
      19,676       37,597       66,642       155,347  
Interest expense                                
Secured borrowings     (2,653 )     (4,809 )     (9,651 )     (63,105 )
Unsecured borrowings     (1,910 )     (1,910 )     (5,701 )     (5,710 )
      (4,563 )     (6,719 )     (15,352 )     (68,815 )
      15,113       30,878       51,290       86,532  
Other (expense) income                                
(Loss) gain on derivative instruments (net)     (1,543 )     1,510       2,939       (161,177 )
Loss on sale of investments (net)                       (67,820 )
Compensation-related expense     (2,075 )     (1,985 )     (6,028 )     (6,519 )
Other general and administrative expense     (1,108 )     (1,321 )     (3,345 )     (3,742 )
Miscellaneous other revenue (expense)                 2       (141 )
      (4,726 )     (1,796 )     (6,432 )     (239,399 )
Net income (loss)     10,387       29,082       44,858       (152,867 )
Less preferred stock dividends     (4,842 )     (4,842 )     (14,526 )     (14,526 )
Net income (loss) to common stockholders   $ 5,545     $ 24,240     $ 30,332     $ (167,393 )
                                 
Net income (loss) per common share                                
Basic   $ 0.06     $ 0.25     $ 0.32     $ (1.76 )
Diluted     0.06       0.25       0.31       (1.76 )
Weighted average common shares outstanding:                                
Basic     96,045       95,698       95,978       95,418  
Diluted     96,612       96,024       96,433       95,418  

 

 

See accompanying notes to consolidated financial statements.

 

 

 

CAPSTEAD MORTGAGE CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands, unaudited)

 

    Quarter Ended     Nine Months Ended  
    September 30     September 30  
    2021     2020     2021     2020  
Net income (loss)   $ 10,387     $ 29,082     $ 44,858     $ (152,867 )
                                 
Other comprehensive (loss) income                                
Amounts related to available for sale securities:                                
Change in net unrealized gain or loss     (32,817 )     (12,563 )     (76,181 )     (13,674 )
Reclassification adjustment for amounts included in net income (loss)                       66,864  
Amounts related to cash flow hedges:                                
Change in net unrealized gain or loss     1,155       2,113       7,359       (19,705 )
Reclassification adjustment for amounts included in net income (loss)     1,519       952       4,701       2,370  
      (30,143 )     (9,498 )     (64,121 )     35,855  
Comprehensive (loss) income   $ (19,756 )   $ 19,584     $ (19,263 )   $ (117,012 )

 

 

See accompanying notes to consolidated financial statements.

 

 

 

 

CAPSTEAD MORTGAGE CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, unaudited)

    Preferred
Stock
    Common
Stock
    Paid-in
Capital
    Accumulated
Deficit
    Accumulated
Other

Comprehensive
Income (Loss)
    Total
Stockholders’
Equity
 
Balance at June 30, 2021   $ 250,946     $ 968     $ 1,269,599     $ (655,406 )   $ 6,906     $ 873,013  
Net income                       10,387             10,387  
Change in unrealized gain on mortgage securities, net                             (32,817 )     (32,817 )
Amounts related to cash flow hedges, net                             2,674       2,674  
Cash dividends:                                                
Common – $0.0725 per share                       (7,059 )           (7,059 )
Preferred – $0.47 per share                       (4,842 )           (4,842 )
Issuance of common stock                                   -  
Other additions to capital           1       898                   899  
Balance at September 30, 2021   $ 250,946     $ 969     $ 1,270,497     $ (656,920 )   $ (23,237 )   $ 842,255  
                                                 
Balance at June 30, 2020   $ 250,946     $ 964     $ 1,266,976     $ (664,749 )   $ 58,752     $ 912,889  
Net income                       29,082             29,082  
Change in unrealized gain on mortgage securities, net                             (12,563 )     (12,563 )
Amounts related to cash flow hedges, net                             3,065       3,065  
Cash dividends:                                                
Common – $0.15 per share                       (14,499 )           (14,499 )
Preferred – $0.47 per share                       (4,842 )           (4,842 )
Issuance of common stock                                    
Other additions to capital           1       696                   697  
Balance at September 30, 2020   $ 250,946     $ 965     $ 1,267,672     $ (655,008 )   $ 49,254     $ 913,829  
                                                 
Balance at December 31, 2020   $ 250,946     $ 965     $ 1,268,439     $ (651,071 )   $ 40,884     $ 910,163  
Net income                       44,858             44,858  
Change in unrealized gain on mortgage securities, net                             (76,181 )     (76,181 )
Amounts related to cash flow hedges, net                             12,060       12,060  
Cash dividends:                                                
Common – $0.3725 per share                       (36,182 )           (36,182 )
Preferred – $1.41 per share                       (14,525 )           (14,525 )
Issuance of common stock                                   -  
Other additions to capital           4       2,058                   2,062  
Balance at September 30, 2021   $ 250,946     $ 969     $ 1,270,497     $ (656,920 )   $ (23,237 )   $ 842,255  
                                                 
Balance at December 31, 2019   $ 250,946     $ 946     $ 1,252,481     $ (444,039 )   $ 13,399     $ 1,073,733  
Net loss                       (152,867 )           (152,867 )
Change in unrealized gain on mortgage securities, net                             53,190       53,190  
Amounts related to cash flow hedges, net                             (17,335 )     (17,335 )
Cash dividends:                                                
Common – $0.45 per share                       (43,577 )           (43,577 )
Preferred – $1.41 per share                       (14,525 )           (14,525 )
Issuance of common stock           16       12,841                   12,857  
Other additions to capital           3       2,350                   2,353  
Balance at September 30, 2020   $ 250,946     $ 965     $ 1,267,672     $ (655,008 )   $ 49,254     $ 913,829  

 

 

See accompanying notes to consolidated financial statements.

 

 

 

 

CAPSTEAD MORTGAGE CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands, unaudited)

 

    Nine Months Ended September 30  
    2021     2020  
Operating activities:                
Net income (loss)   $ 44,858     $ (152,867 )
Adjustments to reconcile net income (loss) to cash provided by operating activities:                
Amortization of investment premiums     65,072       56,135  
Amortization of equity-based awards     2,185       2,466  
Amortization of unrealized loss (net) on de-designated hedges     1,767       37  
Loss on sale of mortgage investments           67,820  
(Gain) loss on derivative instruments (net)     (3,354 )     146,603  
Other depreciation and amortization     103       91  
Net change in receivables, other assets, accounts payable and accrued expenses     4,285       (2,892 )
Net cash provided by operating activities     114,916       117,393  
Investing activities:                
Purchases of residential mortgage investments     (1,967,427 )     (2,474,235 )
Proceeds from sales of residential mortgage investments           2,558,871  
Interest receivable acquired with the purchase of residential mortgage investments     (2,363 )     (4,019 )
Principal collections on residential mortgage investments, including changes in mortgage securities principal remittance receivable     2,628,090       2,769,631  
Net cash provided by investing activities     658,300       2,850,248  
Financing activities:                
Proceeds from repurchase arrangements and similar borrowings     51,364,053       64,953,417  
Principal payments on repurchase arrangements and similar borrowings     (52,219,172 )     (67,583,999 )
Decrease (increase) in cash collateral receivable from derivative counterparties     5,878       (27,852 )
Net receipts from (payments on) derivative settlements     2,204       (140,042 )
Issuance of common stock           12,882  
Other capital stock transactions     (104 )     (108 )
Dividends paid     (58,081 )     (57,548 )
Net cash used in financing activities     (905,222 )     (2,843,250 )
Net change in cash and cash equivalents     (132,006 )     124,391  
Cash and cash equivalents at beginning of period     257,180       105,397  
Cash and cash equivalents at end of period   $ 125,174     $ 229,788  

 

See accompanying notes to consolidated financial statements.

 

 

 

 

CAPSTEAD MORTGAGE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2021

(unaudited)

 

NOTE 1 ¾ BUSINESS

 

Capstead Mortgage Corporation operates as a self-managed real estate investment trust for federal income tax purposes (a “REIT”) and is based in Dallas, Texas. Unless the context otherwise indicates, Capstead Mortgage Corporation, together with its subsidiaries, is referred to as “Capstead” or the “Company.” Capstead earns income from investing in a leveraged portfolio of residential mortgage pass-through securities currently consisting primarily of adjustable-rate mortgage (“ARM”) securities issued and guaranteed by government-sponsored enterprises, either Fannie Mae, Freddie Mac, or by an agency of the federal government, Ginnie Mae. Together these securities are referred to as “Agency Securities” and are considered to have limited, if any, credit risk.

 

NOTE 2 ¾ BASIS OF PRESENTATION

 

Interim Financial Reporting

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the quarter and nine months ended September 30, 2021 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2021. For further information refer to the audited consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2020.

 

NOTE 3 ¾ NET INCOME (LOSS) PER COMMON SHARE

 

Basic net income (loss) per common share is computed by dividing net income, after deducting dividends paid or accrued on preferred stock and allocating earnings to equity awards deemed to be participating securities pursuant to the two-class method, by the average number of shares of common stock outstanding, calculated excluding unvested stock awards. Participating securities include unvested equity awards that contain non-forfeitable rights to dividends prior to vesting.

 

Diluted net income (loss) per common share is computed by dividing the numerator used to compute basic net income (loss) per common share by the denominator used to compute basic net income (loss) per common share, further adjusted for the dilutive effect, if any, of equity awards and shares of preferred stock when and if convertible into shares of common stock. Shares of the Company’s 7.50% Series E Cumulative Redeemable Preferred Stock are contingently convertible into shares of common stock only under certain circumstances associated with the occurrence of a change in control and therefore are not considered dilutive securities absent such circumstances. Any unvested equity awards that are deemed participating securities are included in the calculation of diluted net income (loss) per common share, if dilutive, under either the two-class method or the treasury stock method, depending upon which method produces the more dilutive result.

 

 

 

 

Components of the computation of basic and diluted net income (loss) per common share were as follows for the indicated periods (dollars in thousands, except per share amounts):

 

    Quarter Ended     Nine Months Ended  
    September 30     September 30  
    2021     2020     2021     2020  
Basic net income (loss) per common share                                
Numerator for basic net income (loss) per common share:                                
Net income (loss)   $ 10,387     $ 29,082     $ 44,858     $ (152,867 )
Preferred stock dividends     (4,842 )     (4,842 )     (14,526 )     (14,526 )
Earnings participation of unvested equity awards     (11 )     (37 )     (71 )     (101 )
    $ 5,534     $ 24,203     $ 30,261     $ (167,494 )
Denominator for basic net income (loss) per common share:                                
Average number of shares of common stock outstanding     96,868       96,452       96,836       96,162  
Average unvested stock awards outstanding     (823 )     (754 )     (858 )     (744 )
      96,045       95,698       95,978       95,418  
    $ 0.06     $ 0.25     $ 0.32     $ (1.76 )
Diluted net income (loss) per common share                                
Numerator for diluted net income (loss) per common share   $ 5,534     $ 24,203     $ 30,261     $ (167,494 )
                                 
Denominator for diluted net income (loss) per common share:                                
Denominator for basic net income (loss) per common share     96,045       95,698       95,978       95,418  
Net effect of dilutive equity awards     567       326       455        
      96,612       96,024       96,433       95,418  
    $ 0.06     $ 0.25     $ 0.31     $ (1.76 )

 

There were no potentially dilutive securities excluded from the computation of diluted net income (loss) per common share for the quarter and nine months ended September 30, 2021. There were 383,000 and 911,000 potentially dilutive securities excluded from the computation of diluted net income (loss) per common share for the quarter and nine months ended September 30, 2020, respectively.

 

 

 

 

NOTE 4 ¾ RESIDENTIAL mortgage investments

 

Residential mortgage investments classified by collateral type and interest rate characteristics as of the indicated dates were as follows (dollars in thousands):

 

    Unpaid
Principal
Balance
    Investment
Premiums
    Amortized
Cost Basis
    Carrying
Amount (a)
    Net
WAC (b)
    Average
Yield (c)
 
September 30, 2021                                                
Agency Securities:                                                
Fannie Mae/Freddie Mac ARMs   $ 6,491,992     $ 257,783     $ 6,749,775     $ 6,754,594       2.32 %     1.08 %
Ginnie Mae ARMs     364,003       11,958       375,961       379,512       3.02       0.80  
    $ 6,855,995     $ 269,741     $ 7,125,736     $ 7,134,106       2.36       1.06  
                                                 
December 31, 2020                                                
Agency Securities:                                                
Fannie Mae/Freddie Mac ARMs   $ 6,982,650     $ 252,921     $ 7,235,571     $ 7,310,089       2.67 %     1.51 %
Ginnie Mae ARMs     599,726       17,704       617,430       627,463       3.39       2.05  
    $ 7,582,376     $ 270,625     $ 7,853,001     $ 7,937,552       2.73       1.55  

 

(a) Includes unrealized gains and losses for residential mortgage investments classified as available-for-sale.

 

(b) Net WAC, or weighted average coupon, is the weighted average interest rate of the mortgage loans underlying the indicated investments net of servicing and other fees as of the indicated balance sheet date. Net WAC is expressed as a percentage calculated on an annualized basis on the unpaid principal balances of the mortgage loans underlying these investments.

 

(c) Average yield is presented for the quarter then ended and is based on the cash component of interest income expressed as a percentage calculated on an annualized basis on average amortized cost basis (the “cash yield”) less the effects of amortizing investment premiums. Investment premium amortization is determined using the interest method and incorporates actual and anticipated future mortgage prepayments.

 

Agency Securities are considered to have limited, if any, credit risk because the timely payment of principal and interest is guaranteed. The maturity of Agency Securities is directly affected by prepayments of principal on the underlying mortgage loans. Consequently, actual maturities will be significantly shorter than the portfolio’s weighted average contractual maturity of 293 months.

 

Capstead’s ARM Agency Securities are backed by residential mortgage loans that have coupon interest rates that adjust at least annually to more current interest rates or begin doing so after an initial fixed-rate period. After the initial fixed-rate period, if applicable, mortgage loans underlying ARM securities typically either (i) adjust annually based on specified margins over the one-year London interbank offered rate (“LIBOR”) or the one-year Constant Maturity U.S. Treasury Note Rate (“CMT”), (ii) adjust semiannually based on specified margins over six-month LIBOR or the six-month Secured Overnight Financing Rate (“SOFR”), or (iii) adjust monthly based on specified margins over indices such as one-month LIBOR, the Eleventh District Federal Reserve Bank Cost of Funds Index, or over a rolling twelve month average of the one-year CMT index, usually subject to periodic and lifetime limits, or caps, on the amount of such adjustments during any single interest rate adjustment period and over the contractual term of the underlying loans.

 

Capstead classifies its ARM investments based on average number of months until coupon reset (“months to roll”). Months to roll is an indicator of asset duration which is a measure of market price sensitivity to interest rate movements. A shorter duration generally indicates less interest rate risk. Current-reset ARM investments have months to roll of less than 18 months while longer-to-reset ARM investments have months to roll of 18 months or greater.

 

 

 

 

As of September 30, 2021, the average months to roll for the Company’s $2.71 billion (amortized cost basis) in current-reset ARM investments was approximately seven months while the average months to roll for the Company’s $4.41 billion (amortized cost basis) in longer-to-reset ARM investments was approximately 65 months.

 

The Company did not sell any securities during the quarter and nine months ended September 30, 2021. In March 2020, the Company sold available-for-sale securities using the specific identification method for proceeds totaling $2.56 billion recognizing no gross realized gains and gross realized losses totaling $67.8 million.

 

NOTE 5 ¾ SECURED borrowings

 

Capstead pledges its Residential mortgage investments as collateral for secured borrowings primarily in the form of repurchase arrangements with commercial banks and other financial institutions. Repurchase arrangements entered into by the Company involve the sale and a simultaneous agreement to repurchase the transferred assets at a future date and are accounted for as financings. The Company maintains the beneficial interest in the specific securities pledged during the term of each repurchase arrangement and receives the related principal and interest payments.

 

The terms and conditions of secured borrowings are negotiated on a transaction-by-transaction basis when each such borrowing is initiated or renewed. The amount borrowed is generally equal to the fair value of the securities pledged, as determined by the lending counterparty, less an agreed-upon discount, referred to as a “haircut.” Interest rates are generally fixed based on prevailing rates corresponding to the terms of the borrowings. Interest may be paid monthly or at the termination of a borrowing at which time the Company may enter into a new borrowing at prevailing haircuts and rates with the same lending counterparty or repay that counterparty and negotiate financing with a different lending counterparty. None of the Company’s lending counterparties are obligated to renew or otherwise enter into new borrowings at the conclusion of existing borrowings. In response to declines in fair value of pledged securities due to changes in market conditions or the publishing of monthly security pay-down factors, lending counterparties typically require the Company to post additional securities as collateral, pay down borrowings or fund cash margin accounts with the counterparties in order to re-establish the agreed-upon collateral requirements. These actions are referred to as margin calls. Conversely, in response to increases in fair value of pledged securities, the Company routinely margin calls its lending counterparties in order to have previously pledged collateral returned.

 

 

 

 

Secured borrowings (and related pledged collateral, including accrued interest receivable), classified by collateral type and remaining maturities, and related weighted average borrowing rates as of the indicated dates were as follows (dollars in thousands):

 

Collateral Type   Agency
Securities
Pledged
    Accrued
Interest
Receivable
    Borrowings
Outstanding
    Average
Borrowing

Rates
 
September 30, 2021                                
Borrowings under repurchase arrangements with maturities of 30 days or less   $ 6,769,102     $ 12,697     $ 6,463,964       0.11 %
                                 
December 31, 2020                                
Borrowings under repurchase arrangements with maturities of 30 days or less   $ 5,249,989     $ 12,597     $ 4,972,181       0.21 %
Borrowings under repurchase arrangements with maturities of 31 to 90 days     1,939,034       4,225       1,846,902       0.20  
Borrowings under repurchase arrangements with maturities of greater than 90 days     522,969       1,167       500,000       0.29  
    $ 7,711,992     $ 17,989     $ 7,319,083       0.21  

 

Average secured borrowings outstanding were $6.7 billion and $7.4 billion during the quarters ended September 30, 2021 and December 31, 2020, respectively. Average secured borrowings outstanding during the indicated periods differed from respective ending balances due to changes in portfolio levels and differences in the timing of portfolio acquisitions relative to portfolio runoff.

 

 

 

 

NOTE 6 ¾ USE OF DERIVATIVES, OFFSETTING DISCLOSURES AND CHANGES IN OTHER COMPREHENSIVE INCOME BY COMPONENT

 

Capstead’s portfolio of derivative financial instruments (“Derivatives”) hedge the variability of the underlying benchmark interest rate of current and forecasted 30- to 90-day secured borrowings. The Company attempts to mitigate exposure to higher interest rates primarily by entering into Overnight Index Swap (“OIS”)- and SOFR-indexed, pay-fixed, receive-variable, interest rate swap agreements for terms between eighteen months and three years. From an economic perspective, this hedge relationship establishes a relatively stable fixed rate on related borrowings because the variable-rate payments received on the swap agreements offset a portion of the interest accruing on the borrowings, leaving primarily the fixed-rate swap payments as the Company’s effective borrowing rate. Additionally, changes in fair value of these Derivatives tend to partially offset opposing changes in fair value of the Company’s residential mortgage investments that can occur in response to changes in market interest rates.

 

During the nine months ended September 30, 2021, Capstead entered into swap agreements with notional amounts totaling $1.28 billion requiring fixed-rate interest payments averaging 0.29%. The Company did not enter into any swap agreements during the quarter ended September 30, 2021. No swap agreements matured during the quarter and nine months ended September 30, 2021. At September 30, 2021 the Company’s swap positions related to secured borrowings had the following characteristics (dollars in thousands):

 

Period of Contract Expiration   Notional
Amount
    Average Fixed-Rate
Payment Requirement
 
Second quarter 2022   $ 400,000       0.02 %
Third quarter 2022     1,200,000       0.01  
Fourth quarter 2022     900,000       0.07  
First quarter 2023     50,000       0.13  
Second quarter 2023     350,000       0.20  
Third quarter 2023     100,000       0.03  
Fourth quarter 2023     374,500       0.09  
First quarter 2024     150,000       0.28  
Second quarter 2024     725,000       0.34  
    $ 4,249,500          

 

The Company has three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements with notional amounts totaling $100 million and average fixed rates of 4.09% with 20-year payment terms coinciding with the floating-rate terms of the Company’s Unsecured borrowings that mature in 2035 and 2036. These Derivatives, which are designated as cash flow hedges for accounting purposes, hedge the variability of the underlying benchmark interest rate associated with the floating-rate terms of these long-term borrowings. These Derivatives’ LIBOR-indexed receive rates match the underlying floating-rate terms of the Company’s Unsecured borrowings and therefore the eventual replacement of the LIBOR index on these Derivatives is not expected to have any financial impact.

 

 

 

 

Interest rate swap agreements are measured at fair value on a recurring basis primarily using Level 2 Inputs in accordance with ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820). Fair value estimates for these Derivatives are calculated using the net discounted future fixed cash payments and the discounted future variable cash receipts which are based on expected future interest rates derived from observable market interest rate curves. The Company also incorporates both its own nonperformance risk and its counterparties’ nonperformance risk in determining fair value. In considering the effect of nonperformance risk, the Company considered the impact of netting and credit enhancements, such as collateral postings and guarantees, and has concluded that counterparty risk is not significant to the overall valuation.

 

The fair value of exchange-traded swap agreements hedging Secured borrowings is calculated including accrued interest and net of variation margin amounts received or paid through the exchange, resulting in separately presenting on the balance sheet a significantly reduced fair value amount representing the unsettled fair value of these Derivatives. Non-exchange traded swap agreements held as cash flow hedges of Unsecured borrowings are reported at fair value calculated excluding accrued interest. Cash collateral receivable from derivative counterparties includes initial margin for all Derivatives and variation margin for non-exchange traded Derivatives. Accrued interest for non-exchange traded swap agreements is included in Accounts payable and accrued expenses.

 

The following tables include fair value and other related disclosures regarding all Derivatives held as of and for the indicated periods (in thousands):

 

    Balance Sheet   September 30     December 31  
    Location   2021     2020  
Balance sheet-related                    
Swap agreements in a loss position (a liability) related to unsecured borrowings   (a)   $ (31,191 )   $ (41,484 )
Related net interest payable   (b)     (1,113 )     (597 )
        $ (32,304 )   $ (42,081 )

 

(a) The fair value of Derivatives with unrealized gains are aggregated and recorded as an asset on the face of the Balance Sheets separately from the fair value of Derivatives with unrealized losses that are recorded as a liability.

 

(b) Included in “Accounts payable and accrued expenses” on the face of the Balance Sheets.

 

 

 

 

    Location of
Gain or (Loss)
Recognized in
  Quarter Ended
September 30
    Nine Months Ended
September 30
 
    Net Income   2021     2020     2021     2020  
Income statement-related                                    
Component of Secured borrowings-related effects on interest expense:                                    
Amortization of unrealized gain, net of unrealized losses on de-designated Derivatives       $ (530 )   $ (18 )   $ (1,767 )   $ (37 )
    (a)     (530 )     (18 )     (1,767 )     (37 )
Component of Unsecured borrowings-related effects on interest expense:                                    
Amount of loss reclassified from Accumulated other comprehensive income   (b)     (989 )     (934 )     (2,934 )     (2,333 )
Increase in interest expense as a result of the use of Derivatives       $ (1,519 )   $ (952 )   $ (4,701 )   $ (2,370 )
                                     
Realized and unrealized gain (loss) on non-designated Derivatives (net) related to:                                    
Interest rate swap agreements       $ (1,543 )   $ 1,510     $ 2,939     $ (158,378 )
Eurodollar futures                           (2,799 )
    (c)   $ (1,543 )   $ 1,510     $ 2,939     $ (161,177 )
                                     
Other comprehensive income-related                                    
Amount of gain (loss) recognized in Other comprehensive (loss) income       $ 1,155     $ 2,113     $ 7,359     $ (19,705 )

 

 

(a) Included in “Interest expense: Secured borrowings” on the face of the Consolidated Statements of Operations.

(b) Included in “Interest expense: Unsecured borrowings” on the face of the Consolidated Statements of Operations.
(c) Included in “Loss on derivative instruments (net)” on the face of the Consolidated Statement of Operations.

 

Capstead’s swap agreements and borrowings under repurchase arrangements are subject to master netting arrangements in the event of default on, or termination of, any one contract. See NOTE 5 for more information on the Company’s use of secured borrowings. The following tables provide disclosures concerning offsetting of financial liabilities and Derivatives as of the indicated dates (in thousands):

 

    Offsetting of Derivative Assets  
          Gross     Net Amounts     Gross Amounts Not Offset        
    Gross     Amounts     of Assets     in the Balance Sheet (b)        
    Amounts of     Offset in     Presented in           Cash        
    Recognized     the Balance     the Balance     Financial     Collateral     Net  
    Assets (a)     Sheet (a)     Sheet     Instruments     Received     Amount  
September 30, 2021                                    
Counterparty 4   $ 4,687     $ (4,687 )   $     $     $     $  
December 31, 2020                                                
Counterparty 4   $ 2,673     $ (2,673 )   $     $     $     $  

 

(a) Included in gross amounts of recognized assets is the fair value of exchange-traded swap agreements, calculated including accrued interest. Included in gross amounts offset in the balance sheet are variation margin amounts associated with exchange-traded swaps at September 30, 2021.

 

(b) Amounts presented are limited to recognized liabilities and cash collateral received associated with the indicated counterparty sufficient to reduce the related Net Amount to zero in accordance with ASU No. 2011-11, as amended by ASU No. 2013-01.

 

 

 

 

    Offsetting of Financial Liabilities and Derivative Liabilities  
          Gross     Net Amounts     Gross Amounts Not Offset        
    Gross     Amounts     of Liabilities     in the Balance Sheet (c)        
    Amounts of     Offset in     Presented in           Cash        
    Recognized     the Balance     the Balance     Financial     Collateral     Net  
    Liabilities (a)     Sheet (a)     Sheet (b)     Instruments     Pledged     Amount  
September 30, 2021                                    
Derivatives by counterparty:                                                
Counterparty 1   $ 32,304     $     $ 32,304     $     $ (32,304 )   $  
Counterparty 4     328       (328 )                        
      32,632       (328 )     32,304             (32,304 )      
Borrowings under repurchase arrangements (d)     6,464,196             6,464,196       (6,464,196 )            
    $ 6,496,828     $ (328 )   $ 6,496,500     $ (6,464,196 )   $ (32,304 )   $  
December 31, 2020                                                
Derivatives by counterparty:                                                
Counterparty 1   $ 42,082     $     $ 42,082     $     $ (42,082 )   $  
Counterparty 4     257       (257 )                        
      42,339       (257 )     42,082             (42,082 )      
Borrowings under repurchase arrangements (d)     7,320,090             7,320,090       (7,320,090 )            
    $ 7,362,429     $ (257 )   $ 7,362,172     $ (7,320,090 )   $ (42,082 )   $  
(a) Included in gross amounts of recognized liabilities is the fair value of non-exchange traded swap agreements (Counterparty 1) and exchange-traded swap agreements (Counterparty 4), calculated including accrued interest. Included in gross amounts offset in the balance sheet are variation margin amounts associated with exchange-traded swap agreements at September 30, 2021.
     
(b) Amounts presented are limited to recognized liabilities and cash collateral received associated with the indicated counterparty sufficient to reduce the related Net Amount to zero in accordance with ASU No. 2011-11, as amended by ASU No. 2013-01.
     
(c) Amounts presented are limited to recognized assets and collateral pledged associated with the indicated counterparty sufficient to reduce the related Net Amount to zero in accordance with ASU No. 2011-11, as amended by ASU No. 2013-01.
     
(d) Amounts include accrued interest payable of $232,000 and $1.0 million on borrowings under repurchase arrangements as of September 30, 2021 and December 31, 2020, respectively.

 

The amount of unrealized losses, net of unrealized gains, included in Accumulated other comprehensive income and scheduled to be recognized in the Consolidated Statements of Operations over the next twelve months primarily in the form of a fixed-rate swap payments in excess of current market rates on swaps related to unsecured borrowings and amortization of net unrealized losses on de-designated interest rate swaps totaled $4.3 million at September 30, 2021. Changes in Accumulated other comprehensive income by component for the quarter and nine months ended September 30, 2021 were as follows (in thousands):

 

 

 

 

    Unrealized
Gains and Losses
on Cash Flow
Hedges
    Unrealized Gains
and Losses on

Available-for-Sale

Securities
    Total
Balance at June 30, 2021   $ (34,281 )   $ 41,187     $6,906
Activity for the quarter ended September 30, 2021:                
Other comprehensive income (loss) before reclassifications     1,155       (32,817 )   (31,662)
Amounts reclassified from accumulated other comprehensive income (loss)     1,519           1,519 
Other comprehensive income (loss)     2,674       (32,817 )   (30,143)
Balance at September 30, 2021   $ (31,607 )   $ 8,370     $(23,237)
                 
Balance at December 31, 2020   $ (43,667 )   $ 84,551     $40,884
Activity for the nine months ended September 30, 2021:                
Other comprehensive income (loss) before reclassifications     7,359       (76,181 )   (68,822)
Amounts reclassified from accumulated other comprehensive income     4,701           4,701 
Other comprehensive income (loss)     12,060       (76,181 )   (64,121)
Balance at September 30, 2021   $ (31,607 )   $ 8,370     $(23,237)

 

NOTE 7 ¾ unsecured BORROWINGS

 

Unsecured borrowings consist of 30-year junior subordinated notes issued in 2005 and 2006 and maturing in 2035 and 2036, for a total face amount of $100 million. The notes are currently redeemable, in whole or in part, without penalty, at the Company’s option. Balances net of deferred issuance costs, and related weighted average interest rates as of the indicated dates (calculated including issuance cost amortization and adjusted for effects of related Derivatives held as cash flow hedges) were as follows (dollars in thousands):

 

    September 30, 2021     December 31, 2020  
    Borrowings
Outstanding
    Average
Rate
    Borrowings
Outstanding
    Average
Rate
 
Junior subordinated notes maturing in:                                
October 2035 ($35,000 face amount)   $ 34,460       7.86 %   $ 34,431       7.87 %
December 2035 ($40,000 face amount)     39,464       7.63       39,435       7.64  
September 2036 ($25,000 face amount)     24,645       7.67       24,627       7.68  
    $ 98,569       7.72     $ 98,493       7.73  

 

NOTE 8 ¾ FAIR VALUE

 

The fair value of Capstead’s financial assets and liabilities are influenced by changes in, and market expectations for changes in, interest rates and market liquidity conditions, as well as other factors beyond the control of management. All fair values were determined using Level 2 Inputs in accordance with ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820).

 

 

 

 

Residential mortgage investments, all of which are mortgage securities classified as available-for-sale, are measured at fair value on a recurring basis. In determining fair value estimates the Company considers recent trading activity for similar investments and pricing levels indicated by lenders in connection with designating collateral for secured borrowings, provided such pricing levels are considered indicative of actual market clearing transactions. In determining fair value estimates for Secured borrowings with initial terms of greater than 120 days, the Company considers pricing levels indicated by lenders for entering into new transactions using similar pledged collateral with terms equal to the remaining terms of these borrowings. The Company bases fair value for Unsecured borrowings on discounted cash flows using Company estimates for market yields. Excluded from these disclosures are financial instruments for which cost basis is deemed to approximate fair value due primarily to the short duration of these instruments, which are valued using primarily Level 1 measurements, including Cash and cash equivalents, Cash collateral receivable from derivative counterparties, receivables, payables and secured borrowings with initial terms of 120 days or less. See NOTE 6 for information relative to the valuation of interest rate swap agreements.

 

Fair value-related disclosures for financial instruments other than debt securities were as follows as of the indicated dates (in thousands):

 

        September 30, 2021     December 31, 2020  
    Fair
Value

Hierarchy
  Carrying
Amount
    Fair
Value
    Carrying
Amount
    Fair
Value
 
Financial liabilities:                                    
Secured borrowings with initial terms of greater than 120 days   Level 2   $     $     $ 500,000     $ 500,100  
Unsecured borrowings   Level 2     98,569       73,300       98,493       59,900  
Unsecured borrowings-related interest rate swap agreements   Level 2     31,191       31,191       41,484       41,484  

 

Fair value-related disclosures for debt securities were as follows as of the indicated dates (in thousands):

 

    Amortized     Gross Unrealized        
    Cost Basis     Gains     Losses     Fair Value  
September 30, 2021                        
Agency Securities classified as available-for-sale:                        
Fannie Mae/Freddie Mac   $ 6,749,775     $ 42,627     $ 37,808     $ 6,754,594  
Ginnie Mae     375,961       4,286       735       379,512  
                                 
December 31, 2020                                
Agency Securities classified as available-for-sale:                                
Fannie Mae/Freddie Mac     7,235,571       87,158       12,640       7,310,089  
Ginnie Mae     617,430       10,541       508       627,463  

 

    September 30, 2021     December 31, 2020  
    Fair
Value
    Unrealized
Loss
    Fair
Value
    Unrealized
Loss
 
Securities in an unrealized loss position of one year or greater:                        
Fannie Mae/Freddie Mac   $ 231,456     $ 3,664     $ 690,227     $ 9,533  
Ginnie Mae     32,863       362       27,462       285  
Securities in an unrealized loss position less than one year:                                
Fannie Mae/Freddie Mac     3,827,872       34,144       583,870       3,107  
Ginnie Mae     48,331       373       41,527       223  
    $ 4,140,522     $ 38,543     $ 1,343,086     $ 13,148  

 

 

 

 

From a credit risk perspective, federal government support for Fannie Mae and Freddie Mac helps ensure that fluctuations in value are due to interest rate changes and are not due to credit risk associated with these securities. The unrealized losses on the Company’s investment in ARM Agency Securities were caused by interest rate changes, and the contractual cash flows of those investments are guaranteed by an agency of the U.S. government. The Company does not intend to sell the investments as of September 30, 2021 and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases.

 

NOTE 9 ¾ EQUITY INCENTIVE PLAN

 

All equity-based awards and other long-term incentive awards are made pursuant to the Company’s Amended and Restated 2014 Flexible Incentive Plan that was approved by stockholders in May 2014. At September 30, 2021, this plan had 1,850,645 shares of common stock remaining available for future issuances.

 

Long-term Equity-based Awards – Performance-based Restricted Stock Units (“RSUs”)

 

RSU activity and related information for the nine months ended September 30, 2021 is summarized below:

 

During the quarter and nine months ended September 30, 2021, the Company recognized in Compensation-related expense $270,000 and $427,000, respectively, related to RSU awards. Unrecognized estimated compensation expense for these awards totaled $1.6 million at September 30, 2021, to be expensed over a weighted average period of 1.4 years (assumes estimated attainment levels for the related performance metrics will be met).

 

          Weighted  
          Average  
    Number of     Grant Date  
    Shares     Fair Value  
Unvested RSU awards outstanding at December 31, 2020     581,365     $ 7.83  
Grants     267,573       5.86  
Forfeitures     (111,897 )     8.71  
Vestings     (71,240 )     8.71  
Unvested RSU awards outstanding at September 30, 2021     665,801       6.80  

 

Dividends accrue from the date of grant and will be paid in cash to the extent the units convert into shares of common stock following completion of the related performance periods. If these shares do not vest, the related dividends will be forfeited. Included in Common stock dividends payable at September 30, 2021 are estimated dividends payable pertaining to these awards of $361,000.

 

Long-term Equity-based Awards – Restricted Stock Awards

 

Restricted stock award activity for the nine months ended September 30, 2021 is summarized below:

 

          Weighted  
          Average  
    Number of     Grant Date  
    Shares     Fair Value  
Unvested stock awards outstanding at December 31, 2020     768,041     $ 7.42  
Grants     363,304       5.72  
Forfeitures     (21,145 )     6.76  
Vestings     (287,420 )     7.63  
Unvested stock awards outstanding at September 30, 2021     822,780       6.61  

 

 

 

 

During the quarter and nine months ended September 30, 2021, the Company recognized in Compensation-related expense $455,000and $1.3 million, respectively, related to amortization of the grant date fair value of employee stock awards. In addition, during the quarter and nine months ended September 30, 2021, the Company recognized in Other general and administrative expense $175,000 and $438,000, respectively, related to amortization of the grant date fair value of director stock awards. Unrecognized compensation expense for unvested stock awards for employees and directors totaled $2.3 million as of September 30, 2021, to be expensed over a weighted average period of 1.3 years.

 

Service-based stock awards issued to non-executive employees and to directors receive dividends on a current basis without risk of forfeiture if the related awards do not vest. Stock awards issued to executives defer the payment of dividends accruing between the grant dates and the end of related service periods. If these awards do not vest, the related accrued dividends will be forfeited. Included in Common stock dividend payable at September 30, 2021 are estimated dividends payable pertaining to these awards totaling $584,000.

 

NOTE 10 ¾ SUBSEQUENT EVENTS

 

Completion of Merger with FBRT

 

On October 19, 2021, the Company announced the completion of its merger with Franklin BSP Realty Trust, Inc. (“FBRT”) pursuant to the terms of the Agreement and Plan of Merger, dated as of July 25, 2021, as amended by the First Amendment to Agreement and Plan of Merger, dated as of September 22, 2021 (as amended, the “Merger Agreement”), by and among FBRT, Capstead, Rodeo Sub I, LLC (“Rodeo Sub I”), a wholly-owned subsidiary of FBRT, and FBRT’s external manager, Benefit Street Partners L.L.C. (“BSP”). After the close of trading on October 18, 2021, Capstead ceased to be publicly traded on the New York Stock Exchange (“NYSE”). At the open of trading on October 19, 2021, the combined company began trading on the NYSE under the ticker symbol “FBRT”.

 

At the effective time of the merger, each issued and outstanding share of common stock of Capstead (“Capstead Common Stock”) was converted into the right to receive (i) from FBRT, 0.3288 newly-issued shares of common stock of FBRT (“FBRT Common Stock”), (ii) from FBRT, cash consideration of $0.21 per share and (iii) from BSP, cash consideration of $0.73 per share. In addition, each outstanding share of Capstead’s 7.50% Series E Cumulative Redeemable Preferred Stock was converted into the right to receive one newly-issued share of FBRT’s 7.50% Series E Cumulative Redeemable Preferred Stock (the “FBRT Series E Preferred Stock”). At the open of trading on October 19, 2021, the FBRT Series E Preferred Stock began trading on the NYSE under the ticker symbol “FBRT PRE”.

 

Litigation Relating to the Merger

 

On August 31, 2021, Shiva Stein, a purported shareholder of the Company, filed a lawsuit in the United States District Court for the Southern District of New York, styled Shiva Stein v. Capstead Mortgage Corporation, et al., No. 1:21-cv-7306 (referred to as the “Stein Lawsuit”). The Stein Lawsuit asserts claims against Capstead, members of the Capstead board of directors, (the “Capstead Board”), BSPRT and Rodeo Sub I.

 

On September 1, 2021, Matthew Hopkins, a purported shareholder of the Company, filed a lawsuit in the United States District Court for the Southern District of New York, styled Matthew Hopkins v. Capstead Mortgage Corporation, et al., No. 1:21-cv-07369 (referred to as the “Hopkins Lawsuit”). The Hopkins Lawsuit asserts claims against Capstead, members of the Capstead Board, BSPRT and Merger Sub and BSPRT Advisor.

 

On September 11, 2021, Bryan Harrington, a purported shareholder of the Company, filed a lawsuit in the United States District Court for the Eastern District of New York, styled Bryan Harrington v. Capstead Mortgage Corporation, et al., No. 1:21-cv-05080 (referred to as the “Harrington Lawsuit”). The Harrington Lawsuit asserts claims against Capstead and members of the Capstead Board.

 

On September 24, 2021, Randy Gill, a purported shareholder of the Company, filed a lawsuit in the United States District Court for the Southern District of New York, styled  Randy Gill v. Capstead Mortgage Corporation, et al., No. 1:21-cv-07973 (referred to as the “Gill Lawsuit”). The Gill Lawsuit asserts claims against Capstead and members of the Capstead Board.

 

On October 1, 2021, Jordan Wilson, a purported shareholder of the Company, filed a lawsuit in the United States District Court for the Southern District of New York, styled  Jordan Wilson v. Capstead Mortgage Corporation, et al., No. 1:21-cv-08147-UA (referred to as the “Wilson Lawsuit”). The Wilson Lawsuit asserts claims against Capstead and members of the Capstead Board.

 

We intend to vigorously defend the Company and our board of directors against the lawsuits.

 

 

 

Exhibit 99.3

 

UNAUDITED PRO FORMA FINANCIAL STATEMENTS

 

Introduction

 

The following unaudited pro forma combined balance sheet as of September 30, 2021 and the unaudited pro forma combined statement of income for the year ended December 31, 2020, and the nine months ended September 30, 2021, are based on the historical financial statements of Franklin BSP Realty Trust, Inc. (“FBRT”) and Capstead Mortgage Corporation (“Capstead”) after giving effect to the transactions (the “Merger”) contemplated by that certain Agreement and Plan of Merger, dated as of July 25, 2021, as amended pursuant to that certain First Amendment to Agreement and Plan of Merger, dated as of September 22, 2021 (as amended, the “Merger Agreement”), by and FBRT, Rodeo Sub I, LLC (“Merger Sub”), Capstead and, solely for the purposes set forth therein, Benefit Street Partners L.L.C., FBRT’s external manager (“BSP”). For purposes of presenting the pro forma financial information, the unaudited pro forma combined balance sheet as of September 30, 2021 assumes the Merger had closed at the balance sheet date and for the unaudited pro forma combined statements of income, the Merger is assumed to have occurred as of the beginning of the earliest period presented.

 

In accordance with Accounting Standards Codification Topic 805, “Business Combinations,” which is referred to as ASC 805, because the assets and liabilities of Capstead do not meet the definition of a business, the transaction is expected to be accounted for as an asset acquisition. The final allocation of the consideration paid will be determined after the Merger is completed and after completion of a final analysis to determine the estimated relative fair values of assets and liabilities.

 

In accordance with ASC 805, FBRT will measure the cost of the net assets acquired on the basis of the fair value of the consideration given, inclusive of transaction costs, which was determined to be more reliably measurable. As the cost of the acquisition, inclusive of transaction costs, is expected to exceed the fair value of the assets acquired, FBRT will allocate the difference on a relative fair value basis to certain qualifying assets of Capstead. FBRT’s management has made these determinations based on various preliminary estimates, which are pending finalization. Final asset acquisition accounting adjustments may differ materially from the pro forma adjustments presented herein.

 

This amount will be capitalized on the balance sheet at the time of acquisition. FBRT currently expects that subsequent to the transaction, all or substantially all of this amount will be recognized in the income statement as an expense over time.

 

The unaudited pro forma combined financial statements are based upon available information, preliminary estimates, and certain assumptions that FBRT believes are reasonable in the circumstances, as set forth in the notes to the unaudited pro forma combined financial statements.

 

The unaudited pro forma combined financial statements are presented for informational purposes only and are not necessarily indicative of the future financial position or results of operations of the combined company after the Merger or the combined financial position or the results of operations that would have been realized had the acquisition been consummated during the period or as of the dates for which the unaudited pro forma combined financial statements are presented.

 

Certain reclassification adjustments have been made to the presentation of Capstead’s historical financial statements to conform them to the presentation followed by FBRT. The unaudited pro forma combined financial statements should be read in conjunction with, and are qualified by reference to, FBRT’s historical consolidated financial statements and notes thereto and those of Capstead, which are incorporated herein by reference.

 

As of September 30, 2021, FBRT was named Benefit Street Partners Realty Trust, Inc. (“BSPRT”) and is referred to as such in the pro forma financial statements below.

 

 

 

 

Franklin BSP Realty Trust, Inc.

Pro Forma Balance Sheet

September 30, 2021

(Unaudited)

 

(in thousands)  

Historical

BSPRT

   

Historical

Capstead

   

Pro-Forma

Adjustments

       

BSPRT

Pro-Forma

 
ASSETS                                    
Cash and cash equivalents   $ 91,374     $ 125,174     $ (60,885 )   (A)(E)(I)   $ 155,663  
Restricted Cash     9,531                       9,531  
Commercial mortgage loans, held for investment, net     3,247,646                       3,247,646  
Commercial mortgage loans, held for sale, measured at fair value     99                       99  
Real estate securities, available for sale, measured at fair value           7,134,106       (7,134,106 )   (H)      
Real estate securities, trading, measured at fair value                 7,134,106     (H)     7,134,106  
Derivative instruments, measured at fair value                            
Other real estate investments, measured at fair value     2,547                       2,547  
Receivable for loan repayment     123,311                       123,311  
Accrued interest receivable     17,132                       17,132  
Prepaid expenses and other assets     4,023       136,182       56,900     (A)(E)     197,105  
Intangible lease asset, net of amortization     49,192                       49,192  
Real estate owned, held for sale     90,623                       90,623  
Cash collateral receivable from derivative counterparties           68,533                 68,533  
Total assets   $ 3,635,478     $ 7,463,995     $ (3,985 )       $ 11,095,488  
                                     
LIABILITIES AND STOCKHOLDERS' EQUITY                                    
Collateralized loan obligations   $ 1,792,353     $     $         $ 1,792,353  
Repurchase agreements - commercial mortgage loans     550,156                       550,156  
Repurchase agreements and secured borrowings - real estate securities     46,531       6,463,964                 6,510,495  
Mortgage note payable     23,998                       23,998  
Other financing and loan participation - commercial mortgage loans     37,434                       37,434  
Unsecured borrowings     60,000       98,569                 158,569  
Derivative instruments, measured at fair value           31,192                 31,192  
Interest payable     972                       972  
Distributions payable     20,447       7,920                 28,367  
Accounts payable and accrued expenses     9,318       20,095                 29,413  
Due to affiliates     17,140                       17,140  
Total liabilities   $ 2,558,349     $ 6,621,740     $       $ 9,180,089  
                                     
Redeemable convertible preferred stock Series A, $0.01 par value, 60,000 authorized and 25,567 issued and outstanding   $ 127,603     $     $ (127,603 )   (F)   $  
Redeemable convertible preferred stock Series C, $0.01 par value, 20,000 authorized and 1,400 issued and outstanding   $ 6,969     $     $         $ 6,969  
Redeemable convertible preferred stock Series D, $0.01 par value, 20,000  authorized and 17,950 issued and outstanding   $ 89,677     $     $         $ 89,677  
                                     
EQUITY                                    
Preferred stock, $0.01 par value, 50,000,000 authorized and none issued and outstanding   $     $     $         $  
Preferred stock - $0.10 par value; 100,000 shares authorized: 7.50% Cumulative Redeemable Preferred Stock, Series E, 10,329 shares issued and outstanding           250,946       (250,946 )   (B)      
Class A common stock - $0.01 par value     443       969       (971 )   (C)(F)(G)     441  
Series F Preferred stock - $0.01 par value                 397     (G)     397  
Series E Preferred stock - $0.10 par value; 100,000 shares authorized: 7.50% Cumulative Redeemable Preferred Stock, Series E, 10,329 shares issued and outstanding (formerly Capstead Series E Preferred Stock)                 258,742     (B)     258,742  
Additional paid-in capital     906,517       1,270,497       (563,761 )   (B)(C)(D)(F)(G)     1,613,252  
Accumulated other comprehensive income           (23,237 )     23,237     (D)      
Accumulated deficit     (59,844 )     (656,920 )     656,920     (A)(D)(I)     (59,844 )
Total stockholders' equity   $ 847,116     $ 842,255     $ 123,619         $ 1,812,989  
Non-controlling interest     5,764                       5,764  
Total equity   $ 852,880     $ 842,255     $ 123,619         $ 1,818,753  
Total liabilities, redeemable convertible preferred stock and shareholders' equity   $ 3,635,478     $ 7,463,995     $ (3,984 )       $ 11,095,488  

 

 

 

 

Franklin BSP Realty Trust, Inc.

Pro Forma Income Statement

Nine Months Ended September 30, 2021

(Unaudited)

 

($ in thousands, except per share amounts)  

Historical

BSPRT

   

Historical

Capstead

   

Pro-forma

Adjustments

       

BSPRT

Pro- Forma

 
INCOME                                    
Interest income   $ 138,969     $ 66,642     $         $ 205,611  
Less: Interest expense     35,994       15,351                 51,345  
Net interest income   $ 102,975     $ 51,291     $         $ 154,266  
Revenue from real estate owned     2,447                       2,447  
Total Income   $ 105,422     $ 51,291     $         $ 156,713  
                                     
EXPENSES                                    
Management, general and administrative expense     40,415       9,371       5,211     (B), (C)     54,997  
Total expenses   $ 40,415     $ 9,371     $ 5,211         $ 54,997  
                                     
OTHER (INCOME)/LOSS                                    
Provision/(benefit) for credit losses     (5,452 )                     (5,452 )
Realized (gain)/loss on sale of real estate securities     1,375                       1,375  
Realized (gain)/loss on sale of commercial mortgage loan, held for sale     (206 )                     (206 )
Realized (gain)/loss on sale of real estate owned assets, held-for-sale     (9,810 )                     (9,810 )
Realized (gain)/loss on sale of commercial mortgage loan, held for sale, measured at fair value     (22,211 )                     (22,211 )
Unrealized (gain)/loss on commercial mortgage loans, held for sale, measured at fair value                            
Unrealized (gain)/loss on other real estate investments, measured at fair value     (27 )                     (27 )
Unrealized (gain)/loss on derivatives     (374 )                     (374 )
Trading (gain)/loss                 76,181     (E)     76,181  
Realized (gain)/loss on derivatives     (357 )     (2,939 )               (3,296 )
Total other (income)/loss   $ (37,062 )   $ (2,939 )   $ 76,181         $ 36,180  
Income/(Loss) before income taxes     102,069       44,859       (81,392 )         65,536  
Provision/(benefit) for income tax     3,418                       3,418  
Net income/(loss)   $ 98,651     $ 44,859     $ (81,392 )       $ 62,118  
Less: Preferred stock dividends     12,040       14,526       (12,040 )   (D)     14,526  
Less: Undistributed earnings allocated to preferred stock     10,706             (10,706 )   (D)      
Net income/(loss) applicable to common stockholders   $ 75,905     $ 30,333     $ (58,646 )       $ 47,592  
                                     
Basic earnings per share - as previously reported   $ 1.72                              
Basic earnings per share - pro forma                           (A)   $ 0.53  
Diluted earnings per share - as previously reported   $ 1.71                              
Diluted earnings per share - pro forma                           (A)   $ 0.53  

 

 

 

 

Franklin BSP Realty Trust, Inc.

Pro Forma Income Statement

Year ended December 31, 2020

 

($ in thousands, except per share amounts)  

Historical

BSPRT

   

Historical

Capstead

   

Pro-forma

Adjustments

       

BSPRT

Pro- Forma

 
INCOME                                    
Interest income   $ 179,872     $ 186,735     $         $ 366,607  
Less: Interest expense     66,556       75,511                 142,067  
Net interest income   $ 113,316     $ 111,224     $         $ 224,540  
Revenue from real estate owned     4,299                       4,299  
Total Income   $ 117,615     $ 111,224     $         $ 228,839  
                                     
EXPENSES                                    
Management, general and administrative expense     49,156       13,430       63,679     (A)(C)(D)(E)     126,265  
Total expenses   $ 49,156     $ 13,430     $ 63,679         $ 126,265  
                                     
OTHER (INCOME)/LOSS                                    
Provision/(benefit) for credit losses     13,296                       13,296  
Impairment (gain)/loss on real estate owned assets     398                       398  
Realized (gain)/loss on extinguishment of debt     (3,678 )                     (3,678 )
Realized (gain)/loss on sale of real estate securities     10,137       67,820       (67,820 )   (G)     10,137  
Realized (gain)/loss on sale of commercial mortgage loan, held for sale     (184 )                     (184 )
Realized (gain)/loss on sale of real estate owned asset, held for sale     (1,851 )                     (1,851 )
Realized (gain)/loss on sale of commercial mortgage loan, held-for-sale, measured at fair value     (15,931 )                     (15,931 )
Unrealized (gain)/loss on commercial mortgage loans, held-for-sale, measured at fair value     75                       75  
Unrealized loss on other real estate investments, measured at fair value     32                       32  
Trading (gain)/loss                 95,400     (G)     95,400  
Unrealized loss on derivatives     995                       995  
Realized loss on derivatives     12,486       159,547                 172,033  
Total other (income)/loss   $ 15,775     $ 227,367     $ 27,580         $ 270,722  
Income/(loss) before taxes     52,684       (129,573 )     (91,259 )         (168,148 )
Provision/(benefit) for income tax     (2,062 )                     (2,062 )
Net income/(loss)   $ 54,746     $ (129,573 )   $ (91,259 )       $ (166,086 )
Less: Preferred dividends     14,920       19,368       10,830     (F)     45,118  
Net income/(loss) applicable to common stockholders   $ 39,826     $ (148,941 )   $ (102,089 )       $ (211,204 )
                                     
Diluted net income per share — As Previously Reported   $ 0.90                              
Diluted net income per share — Pro Forma                           (B)   $ (3.31 )

 

 

 

 

Pro Forma Combined Balance Sheet as of September 30, 2021:

 

(A) This adjustment represents the estimated capitalized additional third party costs allocated to the other assets acquired, such as merger and acquisition fees, as well as legal, accounting, and other third party due diligence costs of approximately $11.3 million for BSPRT which would not be a recurring expense. Additionally, $13.2 million of CMC transaction costs were expensed as part of the transaction.

 

(B) This adjustment represents the issuance, at fair value, of shares of BSPRT’s 7.50% Series E Cumulative Redeemable Preferred Stock (“BSPRT Series E Preferred Stock”) in exchange for the retirement of an equal amount of shares of Capstead’s 7.50% Series E Cumulative Redeemable Preferred Stock (“Capstead Series E Preferred Stock”).

 

(C) This adjustment represents the issuance of 31,886,938 shares of BSPRT common stock in exchange for the retirement of 96,981,466 shares of Capstead common stock.

 

(D) This adjustment represents the elimination of Capstead's additional paid-in-capital balance of $1,270.5 million, accumulated deficit of $656.9 million, and accumulated other comprehensive loss of $23.2 million.

 

(E) This adjustment represents the cash consideration of $20.5 million paid by BSPRT to the common shareholders of Capstead as part of the acquisition, and the allocation $45.6 million, representing the excess of the cost of the acquisition over the fair value of Capstead's acquired assets.

 

(F) This adjustment represents the issuance, at par value, of 7,649,632 shares of BSPRT common stock, in exchange for the assumed conversion, at par value, of 25,567 shares of BSPRT’s Series A convertible preferred stock (“Series A Preferred Stock”).

 

(G) This adjustment represents the one-for-ten reverse stock split of BSPRT’s Common Stock and issuance of a stock dividend of nine shares of newly created Series F convertible preferred stock of FBRT (“Series F Preferred Stock”) to each holder of BSPRT Common Stock on October 12, 2021, which resulted in the issuance of 39,733,299 shares of BSPRT Series F Preferred Stock.

 

(H) This adjustment represents the initial designation of the acquired securities portfolio as trading assets of $7.1 billion upon the closing of the Merger.

 

(I) This adjustment represents the deferred compensation and severance costs of $15.9 million that was expensed and paid as part of the Merger.

 

 

 

 

Pro Forma Income Statement for the Nine-Month Period Ended September 30, 2021:

 

(A) Represents the pro forma combined earnings per share of BSPRT common stock, including the impact of the 31,886,938 shares of BSPRT common stock assumed to be issued per adjustment C & G on the above Pro Forma Combined Balance Sheet as of September 30, 2021 and the issuance of 53,172,451 shares of FBRT common stock, in exchange for the assumed conversion of BSPRT’s Series A Preferred Stock, Series C convertible preferred stock (“Series C Preferred Stock”), Series D convertible preferred stock (“Series D Preferred Stock”) and Series F Preferred Stock. Per its terms, the Series A Preferred Stock automatically converted into common stock upon the listing of the common stock in connection with the Merger, the Series C Preferred Stock will convert into common stock upon the one year anniversary of the listing, or up to six months sooner at BSPRT’s option, and the Series D Preferred Stock will automatically convert into common stock upon the one year anniversary of the listing or up to six months sooner at the election of the holders. The Series F Preferred Stock will convert into common stock upon the six month anniversary of the listing. This adjustment represents the issuance, at fair value of shares of BSPRT Series E Preferred Stock in exchange for the retirement of shares of Capstead Series E Preferred Stock.

 

(B) This adjustment of $9.4 million represents the increase in the management fees paid as a result of the acquisition.

 

(C) This adjustment of $4.2 million represents the reduction of compensation costs as a result of the acquisition.

 

(D) Per its terms, the Series A Preferred Stock automatically converted into common stock upon the listing of the common stock in connection with the Merger, the Series C Preferred Stock will convert into common stock upon the one year anniversary of the listing, or up to six months sooner at BSPRT’s option, and the Series D Preferred Stock will automatically convert into common stock upon the one year anniversary of the listing or up to six months sooner at the election of the holders. The Series F Preferred Stock will convert into common stock upon the six month anniversary of the listing. This adjustment represents the reduction of preferred dividends paid and undistributed earnings as a result of the acquisition and conversion of the Series A, Series C, Series D and Series F Preferred Stock.

 

(E) This adjustment represents the reclassification of $76.2 million of gains and losses in other comprehensive income to trading gains due to the initial designation of the acquired securities portfolio as trading assets upon the closing of the Merger. Upon the Merger close, for consolidated financial reporting purposes, the Company applied the stated interest method for calculating interest income on its trading security portfolio consisting of newly acquired residential mortgage back securities. Pre-Merger, Capstead had calculated the interest income earned using the effective interest method. Interest income earned on the residential mortgage back security portfolio presented in the pro forma consolidated financial statements was calculated using the effective interest method.

 

 

 

 

Pro Forma Income Statement for the Year Ended December 31, 2020:

 

(A) Represents the estimated additional total third party costs and related liabilities, such as merger and acquisition fees, as well as legal, accounting, and other third party due diligence costs of approximately $11.3 million for BSPRT and $13.2 million for Capstead.

 

(B) Represents the pro forma combined earnings per share of BSPRT common stock, including the impact of the 31,886,938 shares of BSPRT common stock assumed to be issued per adjustment C & G on the above Pro Forma Combined Balance Sheet as of September 30, 2021 and the issuance of 47,382,931 shares of BSPRT common stock, in exchange for the assumed conversion of Series A and Series F Preferred Stock to the unaudited pro forma combined balance sheets. Per its terms, the Series A Preferred Stock converted immediately upon the listing event and the Series F Preferred Stock are converted into common stock six months following the listing event.

 

(C) Represents $45.6 million of expense for acquired assets that were allocated excess consideration paid in the unaudited pro forma combined financial statements.

 

(D) This adjustment represents the $5.8 million decrease in compensation costs as a result of the Company reducing Capstead's employee headcount upon the close of the transaction.

 

(E) This adjustment represents the $12.6 million increase in the management fees paid as a result of the acquisition.

 

(F) Per its terms, the Series A Preferred Stock automatically converted into common stock upon the listing of the common stock in connection with the Merger, and the Series F Preferred Stock will convert into common stock upon the six month anniversary of the listing. This adjustment represents the increase of preferred dividends paid as a result of the acquisition and conversion of the Series A and Series F Preferred Stock.

 

(G) This adjustment represents the reclassifcation of $27.6 million of gains and losses in other comprehensive income and $67.8 million of realized loss on sale of real estate securities to trading gains due to the initial designation of the acquired securities portfolio as trading assets upon the close of the Merger agreement. Upon the Merger close, for consolidated financial reporting purposes, the Company will apply the stated interest method for calculating interest income on its trading security portfolio consisting of newly acquired residential mortgage back securities. Pre-Merger, CMC had calculated the interest income earned using the effective interest method. Interest income earned on the residential mortgage back security portfolio presented in the pro forma consolidated financial statements was calculated using the effective interest method.