Good morning and welcome to the Capstead Mortgage Third Quarter Earnings Conference Call. All participants will be in a listen-only mode. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Lindsey Crabbe. Please go ahead.

Good morning. Thank you for attending Capstead third quarter earnings conference call. The third quarter earnings release was issued yesterday October 29 and is posted on our website at www.capstead.com under the Investor Relations tab. The link to this webcast is also in the Investor Relations section of our website and an archive of the webcast will be available for 60 days. A replay of this call will be available through December 1. Details of the replay are included in yesterday’s release. With me today are Andy Jacobs, President and Chief Executive Officer; Phil Reinsch, Executive Vice President and Chief Financial Officer; and Robert Spears, Executive Vice President and Chief Investment Officer. Before we get started, I want to remind you that some of today’s comments could be considered forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are based on certain assumptions and expectations of management. For a detailed list of all the risk factors associated with our business, please refer to our filings with the SEC, which are available on our website. The information contained in this call is current only as of the date of this call, October 30, 2014. The company assumes no obligation to update any statements, including any forward-looking statements made during this call. With that, I will turn the call over to Andy.

Well, good morning and welcome to our third quarter 2014 earnings call. As usual, I have Robert Spears and Phil Ryan – are with me and everybody will be available for questions after a few brief opening remarks. Yesterday, the Federal Reserve Open Market Committee announced it was concluded monthly purchase of the treasuries and agencies later this month. The committee also indicated that they will be maintaining their existing policy of reinvesting and keeping the portfolio at basically the same size going forward. And the purchases – the reinvestments relative to the agency securities has amounted to generally about $15 billion to $20 billion each month and then it’s not likely to end soon. Overall, the QE3 or the buying process has been focused on the 30-year fixed rate loan. So, it’s really not directly relevant to the types of securities that we look at. I think of more interest is the 10-year treasury, which ended the quarter at 2.49% at September 30. However, subsequent to the end of the quarter, the market experienced, what we are calling a flash rally, where the 10-year treasury hit an intraday low of 1.86% on October 15, but it’s now retreated back to a level around 2.30%. That’s back and forth a 63 basis point reduction at that one point, quickly followed by 45 basis point retreat in just a few short weeks. I think it’s fair to say that the homeowner, the mortgage interest rates didn’t have an opportunity to participate in this flash rally to any material extent. This volatility though did have impact as relative to the forward yield curve. What happened is the expectation of the timing of the first Fed movement to raise it to hike rates move toward the end of 2015, but yesterday, FOMC statement…

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question is from Steve Delaney of JMP Securities. Please go ahead.

Thanks. Good morning, everyone. I appreciate you taking the question. Just looking at the third quarter, Andy, it looks like with the $0.05 sequential decline as you commented about the CPR looks to us about 60% of that or $0.03 was speed-related premium amortization and the other 40% due to cost of funds and maybe something else minor. So, we look forward a couple of months. It seems reasonable that just seasonality maybe rates are moving higher, but even then just the winter – the fall/winter seasonality, we are going to get some slower speeds and I appreciate your shorthand. That is helpful. It’s a little fuzzier on the cost of funds, because you were pretty fluid in the month and just help me – tell me if this looks correct. I mean, you have got some current pay swaps running off over the next two quarters about $1.6 billion, but then it looks like fourth quarter or first quarter, you have got $900 million of current forward starting swaps, but excluding anything else you did on repo or maybe any swaps you add, it looks like you have got about a $700 million over the next 6 months actual decline in the notional swap position. And just trying to get a sense for on cost of funds which was up 2 basis points, in the quarter to 51, how should we think about that going forward? Is there any particular – any chance for any benefit with these expiring swaps going off or were they likely be replaced with additional either longer repo or additional forward-starting swaps? Thanks. Sorry for the longwinded question.

Simply, the – as we have told the market, we are going to be targeting a net duration of basically 0 to 6 months and we continue to be in that range. We have stated – we have reduced that down to I guess at the end of the quarter it was about one and a quarter, that’s one of the lower levels we have seen in for sometime, but I will let Robert deal with – talk about the macroness of that. So, you are not going to see us go negative duration for that to any great extent in this environment most likely, but it’s managing the portfolio, but Robert, you want to chime in?

Yes. The biggest driver in the drop in our duration gap was the $1.4 billion in the longer term repo that we put on. So, we look at longer term repo versus swaps at different points in time and we will execute one or the other as we think one is more attractive. And so, yes, we do have swaps rolling off. Obviously, if we replace those, they are at higher levels, but I think that the bigger driver is you need to factor in that $1.4 billion at 53 basis points on the repo side. I think that will kind of get you closer on what our cost of funds will be going forward. The swaps obviously are self-explanatory. You just roll them off and replace them with the ones that we use, but during the last quarter, we used longer term repo much more than we did swaps to manage our duration gap.

Helpful. And can you comment on sort of what – at what point in time during the quarter the impact of the longer repo, was that the beginning of the quarter or the end of the quarter, just so we can help calibrate that in terms of….

Yes. I think you can see with an average of 32 basis points for the quarter, we ended the quarter at 33 basis points, which factors in that $1.4 billion. So, it’s pretty at 53 basis points. So, it’s – you can divide from that that they were put on relatively late in the quarter.

Got it, got it. And just a wrap – a follow-up on that longer repo, can you comment on I guess there is 35, 40 some counterparties out there, how many people are out there that are actually talking to you about repo a year or longer these days? I mean, is that a handful of people?

I would say 5 to 10.

Okay.

And obviously there are people that will offer it, but it’s just not at attractive levels, but I think we have got 5 to 10 counterparties that are interested in adding. And then it’s just a question of rate and once again, we look at that versus the swap market to see if it makes sense. And obviously, yield give up – you are willing to give up a little bit versus swaps due to the nature of it being committed financing.

Sure, sure. I mean, are you hearing any color from the lenders that this is maybe driven by some of these Basel III rules like this liquid funding coverage ratio, it seems like there is a lot of push by the regulators to try to get banks to just extend both sides of their funding and get away from their really short-term repo books and I am just curious whether there is any regulatory driver?

Yes, that’s part of it. And you are hearing both sides of the equation. You are hearing some guys saying balance sheet may shrink, other guys saying they want to grow their repo book. All we can say is right now we have a lot of counterparties approaching us about wanting to do more repo financing. So, we think we have excess repo capacity right now.

Well, guys, thanks for the color. Appreciate it.

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

Thank you and good morning. Just kind of want to dive into the uptick in prepayments. I know you have got a lot of volatility in the short end of the curve. Can you maybe give us some insights into why borrowers tied to shorter rates refi? Are they jumping off when they see longer term rates come down? And then again conversely as rates move up, your prepayment fees seem to go down, is that most of what’s going on or is there other things that we are missing?

Well, I mean, you have seasonal factors. The third quarter is almost always are in peaking speeds. And just generically, ARM speeds were up about 2 CPR, but so were fixed rates to be. So, it wasn’t like ARMs just prepay faster in a vacuum. And yes, you always have – I mean, the 10-year rally and fixed rate came down. So, if some guys will refinance from ARM to a fixed rate particularly your 5/1 type borrower. Our shorter reset – our very short reset season securities, we didn’t really see an uptick in speed. So, it is almost exclusively in our longer reset bucket, but that’s pretty common just because those guys are more rate-sensitive, they are newer loans, higher credit, easier to refinance, they are still kind of low hanging fruit from a mortgage originator standpoint. So, that was where the uptick in speeds was in our book and that’s not uncommon when you see either a decline in rates or initially when you see an uptick in rates as guys rush to refinance at what they think is lower rates before they go up. But our very season in short reset securities are very stable and we don’t see much of a change in their speed.

Okay, that makes sense. That’s really the unseasoned kind of 5/1 hybrid borrower that’s jumping off?

Exactly.

Okay. And if we look out obviously you gave us nice color in terms of the rest of the quarter and into early ‘15. If you kind of look out into next year more broadly under this scenario where the Fed does start raising rates and it creates perhaps a slowdown in the economy, we get a continued rally in treasuries, what – is there any point, as you said this recent rally, people didn’t really have an opportunity to do much, but is there a level if 30-year mortgage rates get to a certain point where you would not be as enamored with a 5/1 complex because of the refinance risks?

Sure. I mean, obviously if you are in an inverted curve environment, I mean right now a 30-year no cost refinance is around 4% and 8%, if that was a dropdown to for whatever reason, if you had a rally in the 5-year and 10-year part of the curve and you are now at 3.5% 30-year mortgage rate and you have a 5/1 borrower that has a 3.5% mortgage – gross coupon. He has got to refinance. But it’s a 25 basis point move isn’t going to make a difference, but I do think if you saw a 50 basis point decline in 30-year fixed rate, it would be a negative, prepay wise for the 5/1 and 7/1 sectors.

Joel, if you look at our acquisitions over a longer period of time measured in years, you look at right now what we have been buying mostly has been kind of the 5/1 type product, a more seasoned 5/1 type product, but I mean the ratio to which of our longer to reset to short reset is towards the higher end of where it’s been over the last 2 years. I mean, you go back just a few years ago and we are buying mostly more the true ARM type product, and that ratio was much higher on a current reset basis. So, it ebbs and flows as to where we are looking at the market and see the opportunities.

But the message is you guys are reasonably well-protected if we saw a rally in mortgage rates next year?

Yes, I think so. I mean, obviously speeds would pickup and if speeds would pickup in everything, but the buffer that our very seasoned book gives us is a nice cushion. I mean, once again, our biggest risk buckets of prepay volatility is in our newer issued longer reset securities that we bought over the last couple of years.

Alright, guys. Thanks for the color. Appreciate it.

Thank you.

(Operator Instructions) Showing no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Lindsey Crabbe for any closing remarks.

Thanks again for joining us today. If you have further questions, please give us a call. We look forward to speaking with you next quarter.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.