Capstead Among REITs Seeking Some Protection Against Prepayment Risk

Savings and loans have some company in their vulnerability to falling interest rates. The drop of nearly 150 basis points in long-term rates since April has left real estate investment trusts that hold mortgages scrambling to protect their portfolios from loan prepayments.

A case in point is Capstead Mortgage Corp. On Dec. 8, the Dallas company increased its fourth-quarter dividend to 61.5 cents, from 61 cents for the third quarter, only to see its shares go into a free fall as investors focused on its statement that further dividend growth would be a challenge.

Gary Gordon, a PaineWebber Inc. analyst, said Capstead's primary sources of earnings-adjustable-rate mortgages and mortgage servicing-are both affected when borrowers refinance their loans.

Capstead's shares were trading at $18.9375 Wednesday, off from a 52-week high of $27.6875. And with rates still low, the company said increasing the dividend was no longer the issue. "The expectation is that we're going to reduce that, and that the range will be 55 to 62 cents," said Andrew F. Jacobs, senior vice president and treasurer.

Thornburg Mortgage Asset Corp., Santa Fe, N.M., also may have to cut its dividend, said Larry A. Goldstone, president and chief operating officer. He projected a payout of $1.70 to $2.10 a share this year, potentially off from $1.97 last year.

"The yields on our assets are not fixed, they're floating," he said, "and therefore as interest rates decline, the yields on our assets decline."

Mr. Gordon said the trusts have hedging strategies to offset prepayment risk. Capstead has focused on buying loans with lower-than-average interest rates, he said.

Thornburg hedges against prepayments by investing in seasoned mortgage loans and in adjustable-rate mortgage products that are not affected by short-term prepayment trends, Mr. Goldstone said. It also buys adjustable- rate mortgages indexed to cost of funds that are out of favor with investors and therefore available at prices below par.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER