Second Quarter 2015 Highlights
- Generated earnings of $24.9 million or $0.22 per diluted common share
- Paid common dividend of $0.31 per common share
- Book value decreased 1.4%, or $0.17 to $12.30 per common share
- Financing spreads on residential mortgage investments decreased 27 basis points to 0.84%
- Mortgage prepayments increased to an annualized constant prepayment rate, or CPR, of 21.98% from 16.66% CPR reported for the first quarter of 2015
- Agency-guaranteed ARM portfolio and leverage ended the quarter at $14.16 billion and 8.76 times long-term investment capital, respectively
Capstead reported net income of $24.9 million or $0.22 per diluted common share for the quarter ended June 30, 2015. This compares to net income of $34.0 million or $0.32 per diluted common share for the quarter ended March 31, 2015. The Company paid a second quarter 2015 dividend of $0.31 per common share on July 20, 2015.
Second Quarter Earnings and Related Discussion
Capstead is a self-managed real estate investment trust, or REIT, for federal income tax purposes. The Company earns income from investing in a leveraged portfolio of short-duration residential adjustable-rate mortgage pass-through securities, referred to as ARM securities, issued and guaranteed by government-sponsored enterprises, either Fannie Mae or Freddie Mac, or by an agency of the federal government, Ginnie Mae. This strategy differentiates the Company from its peers because ARM loans underlying its investment portfolio reset to more current interest rates within a relatively short period of time. This positions the Company to benefit from a potential recovery in financing spreads that typically contract during periods of rising interest rates and can result in smaller fluctuations in portfolio values compared to portfolios containing a significant amount of longer-duration ARM and fixed-rate mortgage securities. Duration is a common measure of market price sensitivity to interest rate movements. A shorter duration generally indicates less interest rate risk.
For the quarter ended June 30, 2015, the Company reported net interest margins related to its residential mortgage investments of $30.2 million compared to $39.4 million for the quarter ended March 31, 2015. Financing spreads on residential mortgage investments averaged 0.84% during the second quarter, a decrease of 27 basis points from financing spreads earned during the first quarter of 2015. Most of the decrease in net interest margins and financing spreads is attributable to higher investment premium amortization resulting from higher mortgage prepayments. Financing spreads on residential mortgage investments is a non-GAAP financial measure based solely on yields on residential mortgage investments, net of borrowing rates on repurchase arrangements and similar borrowings (referred to as repo borrowing rates), adjusted for currently-paying interest rate swap agreements held for hedging purposes.
Yields on Capstead’s residential mortgage investments averaged 1.46% during the second quarter of 2015, a decrease of 24 basis points from yields reported for the first quarter 2015. This decrease is primarily due to an $8.0 million increase in investment premium amortization largely as a result of an increase in average annualized mortgage prepayment rates to 21.98% CPR from 16.66% CPR reported for the first quarter of 2015. The increase in mortgage prepayments reflects lower mortgage interest rates prevailing earlier in the year as well as seasonal factors.
The following table illustrates the progression of the Company’s portfolio of residential mortgage investments for the quarter and six months ended June 30, 2015 (dollars in thousands):
|Residential mortgage investments, beginning of period||$||14,150,084||$||13,908,104|
|Portfolio acquisitions (principal amount) at average lifetime|
|purchased yields of 2.50% and 2.43%, respectively||944,467||1,870,505|
|Investment premiums on acquisitions*||32,339||65,849|
|Portfolio runoff (principal amount)||(919,223||)||(1,617,820||)|
|Investment premium amortization||(33,057||)||(58,135||)|
|Decrease in net unrealized gains on securities classified|
|Residential mortgage investments, end of period||$||14,155,863||$||14,155,863|
|Increase in residential mortgage investments during the|
Residential mortgage investments typically are acquired at a premium to the securities’ unpaid principal balances. Investment premiums are recognized in earnings as portfolio yield adjustments using the interest method over the estimated lives of the related investments. As such, the level of mortgage prepayments impacts how quickly investment premiums are amortized.
Capstead’s repurchase arrangements and similar borrowings totaled $12.97 billion at June 30, 2015 with 26 counterparties at interest rates averaging 0.43%, before adjustment for interest rate swap agreements held for hedging purposes. Unadjusted repo borrowing rates averaged 0.41% during the second quarter of 2015, three basis points higher than average rates reported for the first quarter of 2015, reflecting higher 30- to 90-day borrowing rates and greater use of higher-rate, longer-maturity repo borrowings. After adjusting for currently-paying interest rate swap agreements, repo borrowing rates averaged 0.62% during the second quarter of 2015.
The Company added $200 million in longer-maturity repo borrowings during the second quarter of 2015 with average initial maturities of 18 months and borrowing rates of 0.76%, bringing total repo borrowings with initial maturities of at least 12 months to $2.58 billion at June 30, 2015, with average remaining maturities of eight months and average borrowing rates of 0.63%. Also during the second quarter $900 million notional amount of two-year term swap agreements requiring fixed-rate interest payments averaging 0.74% became effective while $200 million notional amount of swap agreements requiring fixed-rate interest payments averaging 0.43% matured. Portfolio financing-related swap agreements held by the Company at quarter-end totaled $7.80 billion notional amount requiring fixed-rate interest payments averaging 0.57% with average contract expirations of 11 months. Variable payments that are received by the Company under portfolio financing-related swap agreements typically are based on one-month LIBOR and offset a significant portion of the interest owed on a like amount of the Company’s borrowings under repurchase arrangements.
Total operating costs of $3.3 million, expressed as an annualized percentage of long-term investment capital, averaged 0.89% during the second quarter of 2015 compared to an average of 0.94% during the first quarter of 2015. Capstead remains a clear leader in terms of operating cost efficiency among its mortgage REIT peers.
Investment Capital, Portfolio Leverage and Book Value per Common Share
Capstead’s long-term investment capital, which consists of common and perpetual preferred stockholders’ equity and $100 million of long-term unsecured borrowings, decreased $15.8 million during the second quarter to $1.48 billion at quarter-end reflecting lower portfolio pricing levels and dividend distributions in excess of earnings, partially offset by a decrease in unrealized losses on interest rate swap agreements held for hedging purposes and the issuance of $0.9 million in new preferred equity capital under the Company’s continuous offering program. Portfolio leverage (repurchase arrangements and similar borrowings divided by long-term investment capital) increased to 8.76 to one at June 30, 2015 from 8.65 to one at March 31, 2015.
The following table illustrates the progression of the Company’s book value per common share (total stockholders’ equity, less preferred share liquidation preferences, divided by common shares outstanding) as well as changes in book value expressed as percentages of beginning book value for the quarter and six months ended June 30, 2015:
June 30, 2015
Six Months Ended
June 30, 2015
|Book value per common share, beginning of period||$||12.47||$||12.52|
|Change in unrealized gains and losses on|
|mortgage securities classified as available-for-sale||(0.20||)||(0.13||)|
|Change in unrealized gains and losses on interest|
|rate swap agreements designated as cash flow|
|Dividend distributions in excess of earnings||(0.09||)||(0.08||)|
|Other (principally related to equity awards)||0.01||0.01|
|Book value per common share, end of period||$||12.30||$||12.30|
|Decrease in book value per common share during|
|the indicated periods||$||(0.17||)||(1.4||)%||$||(0.22||)||(1.8||)%|
Nearly all of Capstead’s residential mortgage investments and all of its interest rate swap agreements are reflected at fair value on the Company’s balance sheet and related unrealized gains and losses are included in the calculation of book value per common share. The Company’s borrowings, however, are not reflected at fair value on the balance sheet. Fair value is impacted by market conditions, including changes in interest rates, and the availability of financing at reasonable rates and leverage levels, among other factors. The Company’s investment strategy attempts to mitigate these risks by focusing on investments in agency-guaranteed residential mortgage pass-through securities, which are considered to have little, if any, credit risk and are collateralized by ARM loans with interest rates that reset periodically to more current levels generally within five years. Because of these characteristics, the fair value of Capstead’s portfolio is less vulnerable to significant pricing declines caused by credit concerns or rising interest rates compared to leveraged portfolios containing a significant amount of non-agency-guaranteed securities or agency-guaranteed securities backed by longer-duration ARM and/or fixed-rate loans.
Commenting on current operating and market conditions, Andrew F. Jacobs, President and Chief Executive Officer, said, “Portfolio runoff, which consists of scheduled payments as well as prepayments on mortgage loans underlying our residential mortgage investments, significantly impacts our portfolio yields because investment premiums are amortized to earnings based on actual and expected future levels of mortgage prepayments. Mortgage prepayment levels are heavily influenced by the availability of mortgage financing with attractive terms and the overall health of the housing markets and have been elevated in recent months primarily as a result of lower mortgage rates available earlier in the year as well as seasonal factors. This has contributed to higher investment premium amortization and lower yields in the second quarter. Mortgage prepayment rates are expected to begin receding during the third quarter, given current levels of market interest rates.
“Current repo conditions are healthy with opportunities to secure additional longer-term, committed financing at attractive rates. Our future borrowing rates will be dependent on market conditions, including the availability of longer-term borrowings and interest rate swap agreements at attractive rates. During the current quarter we increased portfolio leverage to 8.76 to one at quarter-end from 8.65 to one at March 31, 2015. We are comfortable with this level of leverage given the current health and breadth of the financing market for agency-guaranteed mortgage securities and the composition of our portfolio.
“The first six months of 2015 has been a volatile period from an interest rate perspective, with the ten-year U.S. Treasury rate initially declining 53 basis points to 1.64% by January 30th and then increasing 85 basis points to 2.49% on June 10th before ending the quarter at 2.35%. During this same period we produced an annualized return of 6.4% (consisting of a $0.22 per share decline in book value and cumulative common dividends of $0.62 per share). We believe this result compares favorably with similar mortgage finance companies and speaks to the resiliency inherent in our short-duration ARM investment strategy.
“We remain confident in and focused on our investment strategy of managing a leveraged portfolio of agency-guaranteed residential ARM securities that can produce attractive risk-adjusted returns over the long term while reducing, but not eliminating, sensitivity to changes in interest rates.”
Earnings Conference Call Details
An earnings conference call and live audio webcast will be hosted Thursday, July 30, 2015 at 9:00 a.m. ET. The conference call may be accessed by dialing toll free (877) 505-6547 in the U.S., (855) 669-9657 for Canada, or (412) 902-6660 for international callers. A live audio webcast of the conference call can be accessed via the investor relations section of the Company’s website at www.capstead.com, and an audio archive of the webcast will be available for approximately 90 days. The audio replay will be available one hour after the end of the conference call through October 28, 2015. The replay can be accessed by dialing toll free (877) 344-7529 in the U.S., (855) 669-9658 for Canada, or (412) 317-0088 for international callers and entering conference number 10069328.
Cautionary Statement Concerning Forward-looking Statements
This document contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “will be,” “will likely continue,” “will likely result,” or words or phrases of similar meaning. Forward-looking statements are based largely on the expectations of management and are subject to a number of risks and uncertainties including, but not limited to, the following:
- changes in general economic conditions;
- fluctuations in interest rates and levels of mortgage prepayments;
- the effectiveness of risk management strategies;
- the impact of differing levels of leverage employed;
- liquidity of secondary markets and credit markets;
- the availability of financing at reasonable levels and terms to support investing on a leveraged basis;
- the availability of new investment capital;
- the availability of suitable qualifying investments from both an investment return and regulatory perspective;
- changes in legislation or regulation affecting Fannie Mae, Freddie Mac and similar federal government agencies and related guarantees;
- other changes in legislation or regulation affecting the mortgage and banking industries;
- changes in market conditions as a result of Federal Reserve monetary policy or federal government fiscal challenges;
- deterioration in credit quality and ratings of existing or future issuances of Fannie Mae, Freddie Mac or Ginnie Mae securities;
- changes in legislation or regulation affecting exemptions for mortgage REITs from regulation under the Investment Company Act of 1940; and
- increases in costs and other general competitive factors.
In addition to the above considerations, actual results and liquidity are affected by other risks and uncertainties which could cause actual results to be significantly different from those expressed or implied by any forward-looking statements included herein. It is not possible to identify all of the risks, uncertainties and other factors that may affect future results. In light of these risks and uncertainties, the forward-looking events and circumstances discussed herein may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. Forward-looking statements speak only as of the date the statement is made and the Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, readers of this document are cautioned not to place undue reliance on any forward-looking statements included herein.
|CAPSTEAD MORTGAGE CORPORATION|
|CONSOLIDATED BALANCE SHEETS|
|(in thousands, except ratios, pledged and per share amounts)|
|June 30, 2015||December 31, 2014|
|Residential mortgage investments|
|($13.63 and $13.48 billion pledged under repurchase arrangements|
|at June 30, 2015 and December 31, 2014, respectively)||$||14,155,863||$||13,908,104|
|Cash collateral receivable from interest rate swap counterparties||53,326||53,139|
|Interest rate swap agreements at fair value||318||1,657|
|Cash and cash equivalents||198,600||307,526|
|Receivables and other assets||133,178||118,643|
|Repurchase arrangements and similar borrowings||$||12,967,616||$||12,806,843|
|Interest rate swap agreements at fair value||27,401||27,034|
|Common stock dividend payable||30,706||34,054|
|Accounts payable and accrued expenses||35,014||30,367|
|Preferred stock - $0.10 par value; 100,000 shares authorized:|
|7.50% Cumulative Redeemable Preferred Stock, Series E,|
|8,086 and 7,618 shares issued and outstanding ($202,146|
|and $190,454 aggregate liquidation preferences) at|
|June 30, 2015 and December 31, 2014, respectively||195,466||183,936|
|Common stock - $0.01 par value; 250,000 shares authorized:|
|95,790 and 95,848 shares issued and outstanding at|
|June 30, 2015 and December 31, 2014, respectively||958||958|
|Accumulated other comprehensive income||213,102||227,422|
|Long-term investment capital (Consists of stockholders’ equity and long-term unsecured borrowings) (unaudited)||$||1,480,548||$||1,490,771|
|Portfolio leverage (Repurchase arrangements and similar borrowings divided by long-term investment capital) (unaudited)||8.76:1||8.59:1|
|Book value per common share (based on common shares outstanding and calculated assuming liquidation preferences for preferred stock) (unaudited)||$||12.30||$||12.52|
|CAPSTEAD MORTGAGE CORPORATION|
|CONSOLIDATED STATEMENTS OF INCOME|
|(in thousands, except per share amounts)|
Six Months Ended
|Residential mortgage investments||$||50,341||$||57,092||$||108,986||$||116,537|
|Repurchase arrangements and similar borrowings||(20,098||)||(15,542||)||(39,312||)||(30,949||)|
|Other revenue (expense):|
|Salaries and benefits||(1,103||)||(985||)||(2,152||)||(2,117||)|
|Short-term incentive compensation||(830||)||(397||)||(1,522||)||(937||)|
|Long-term incentive compensation||(227||)||(624||)||(835||)||(1,250||)|
|Other general and administrative expense||(1,170||)||(967||)||(2,319||)||(2,170||)|
|Miscellaneous other revenue (expense)||54||32||107||(53||)|
|Net income available to common stockholders:|
|Less preferred stock dividends||(3,788||)||(3,449||)||(7,530||)||(6,687||)|
|Net income per common share:|
|Weighted average common shares outstanding:|
|Cash dividends declared per share:|
|Series E Preferred||0.47||0.47||0.94||0.94|
|CAPSTEAD MORTGAGE CORPORATION|
|CONDENSED QUARTERLY STATEMENTS OF INCOME AND SELECT OPERATING STATISTICS|
|Condensed Quarterly Statements of Income:|
|(in thousands, except per share amounts)|
|Interest income on residential|
|(before investment premium amortization)||$||83,398||$||83,723||$||82,509||$||82,146||$||82,233||$||81,733|
|Investment premium amortization||(33,057||)||(25,078||)||(26,159||)||(28,284||)||(25,141||)||(22,288||)|
|Related interest expense||(20,098||)||(19,214||)||(18,107||)||(16,099||)||(15,542||)||(15,407||)|
|Other interest income (expense) (a)||(2,023||)||(2,029||)||(2,023||)||(2,044||)||(2,045||)||(2,061||)|
|Salaries and benefits||(1,103||)||(1,049||)||(996||)||(999||)||(985||)||(1,132||)|
|Short-term incentive compensation||(830||)||(692||)||(565||)||(613||)||(397||)||(540||)|
|Long-term incentive compensation||(227||)||(608||)||(201||)||(624||)||(624||)||(626||)|
|Other general and administrative|
|Miscellaneous other revenue|
|Net income per diluted common|
|Average diluted common shares|
|Select Operating Statistics:|
|(dollars in millions, percentages annualized)|
|Average portfolio outstanding|
|Average long-term investment|
|Financing spreads on residential|
|Constant prepayment rate (“CPR”)||21.98||16.66||17.58||19.18||17.22||15.16|
|Operating costs as a percentage|
|Return on common equity capital||7.02||10.10||9.68||9.32||10.82||11.70|
Consists principally of interest on unsecured borrowings.
|CAPSTEAD MORTGAGE CORPORATION|
|QUARTERLY FINANCING SPREAD ANALYSIS|
|Yields on residential mortgage investments: (a)|
|Investment premium amortization||(0.95||)||(0.72||)||(0.77||)||(0.84||)||(0.75||)||(0.67||)||(0.74||)||(1.14||)|
|Related borrowing rates: (b)|
|Repo borrowing rates||0.41||0.38||0.36||0.32||0.32||0.34||0.38||0.37|
|Fixed swap rates||0.55||0.53||0.51||0.50||0.49||0.50||0.52||0.59|
|Adjusted borrowing rates||0.62||0.59||0.56||0.51||0.49||0.49||0.49||0.49|
|Financing spreads on residential mortgage|
Cash yields are based on the cash component of interest income. Investment premium amortization is determined using the interest method which incorporates actual and anticipated future mortgage prepayments. Both are expressed as a percentage calculated on average amortized cost basis for the indicated periods.
Repo borrowing rates represent average rates on repurchase agreements and similar borrowings, before consideration of related currently-paying interest rate swap agreements.
Fixed swap rates represent the average fixed-rate payments made on currently-paying interest rate swap agreements held for portfolio hedging purposes and exclude differences between LIBOR-based variable-rate payments received on these swaps and repo borrowing rates, as well as the effects of any hedge ineffectiveness. These factors equated to 22 basis points on the average currently-paying swap notional amount outstanding for both the first and second quarters of 2015.
Adjusted borrowing rates reflect repo borrowing rates, fixed swap rates and the above mentioned factors, calculated on average related borrowings outstanding for the indicated periods.
Financing spreads on residential mortgage investments, a non-GAAP financial measure, differs from total financing spreads, an all-inclusive GAAP measure, that is based on all interest-earning assets and all interest-paying liabilities. Management believes that presenting financing spreads on residential mortgage investments provides useful information for evaluating the performance of the Company’s portfolio. The following reconciles these two measures.
|Financing spreads on residential|
|Impact of yields on other interest-earning assets*||(0.04||)||(0.04||)||(0.05||)||(0.04||)||(0.05||)||(0.04||)||(0.03||)||(0.02||)|
|Impact of borrowing rates on unsecured|
|borrowings and other interest-paying|
|Total financing spreads||0.74||1.01||0.98||0.99||1.10||1.19||1.15||0.79|
Other interest-earning assets consist of overnight investments and cash collateral receivable from interest rate swap counterparties. Other interest-paying liabilities consist of long-term unsecured borrowings (at a borrowing rate of 8.49%) that the Company considers a component of its long-term investment capital and cash collateral payable to interest rate swap counterparties.
|CAPSTEAD MORTGAGE CORPORATION|
|FAIR VALUE ANALYSIS|
|(in thousands, unaudited)|
|June 30, 2015||December 31, 2014|
Residential mortgage investments
classified as available-for-sale: (a) (b)
|Fannie Mae/Freddie Mac securities:|
|Current-reset ARMs||$ 5,975,349||$165,906||$ 6,141,255||$ 6,340,828||$199,573||$ 204,037|
|Ginnie Mae securities:|
|$13,468,224||$ 440,410||$ 13,908,634||$ 14,148,725||$ 240,091||$ 252,731|
|Interest rate swap positions (c)||$ 7,900,000||$ (27,083)||$ (26,989)||$ (25,309)|
Unrealized gains and losses on residential mortgage securities classified as available-for-sale are recorded as a component of Accumulated other comprehensive income in Stockholders’ equity. Gains or losses are generally recognized in earnings only if sold. Residential mortgage securities classified as held-to-maturity with a cost basis of $3 million and unsecuritized investments in residential mortgage loans with a cost basis of $4 million are not subject to mark-to-market accounting and therefore have been excluded from this analysis.
Capstead classifies its residential ARM securities based on the average length of time until the loans underlying each security reset to more current rates (see page 12 of this release for further information).
To help mitigate exposure to higher interest rates, Capstead typically uses currently-paying and forward-starting one-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements with two-year interest payment terms. The Company has entered into three forward-starting swap agreements with notional amounts totaling $100 million and terms coinciding with the variable-rate terms of the Company’s long-term unsecured borrowings that begin in fourth quarter 2015 and third quarter 2016 and end with their maturities in 2035 and 2036. Swap positions are carried on the balance sheet at fair value with related unrealized gains or losses arising while designated as cash flow hedges for accounting purposes reflected as a component of Accumulated other comprehensive income in Stockholders’ equity and related hedge ineffectiveness recognized in Interest expense. As of June 30, 2015, these swap positions had the following characteristics:
|Period of Contract Expiration||
|Third quarter 2015||$||400,000||0.47||%||$||(189||)||$||(184||)|
|Fourth quarter 2015||1,200,000||0.45||(967||)||(938||)|
|First quarter 2016||1,700,000||0.51||(2,244||)||(2,233||)|
|Second quarter 2016||1,100,000||0.47||(1,211||)||(1,201||)|
|Third quarter 2016||700,000||0.56||(1,077||)||(1,076||)|
|Fourth quarter 2016||800,000||0.66||(1,590||)||(1,590||)|
|First quarter 2017||1,000,000||0.72||(1,619||)||(1,617||)|
|Second quarter 2017||900,000||0.74||(372||)||(336||)|
|(average expiration: 11 months)||7,800,000||0.57||(9,269||)||(9,175||)|
Forward-starting contracts expiring in 2035
|and 2036 related to unsecured borrowings||$||100,000||4.09||$||(17,814||)||$||(17,814||)|
After consideration of portfolio financing-related swap positions, Capstead’s residential mortgage investments and related borrowings had durations as of June 30, 2015 of approximately 11 and 8 months, respectively, for a net duration gap of approximately 3 months. Duration is a measure of market price sensitivity to changes in interest rates. A shorter duration generally indicates less interest rate risk.
|CAPSTEAD MORTGAGE CORPORATION|
|RESIDENTIAL ARM SECURITIES PORTFOLIO STATISTICS|
|(as of June 30, 2015)|
|(dollars in thousands, unaudited)|
Cost Basis (a)
|Fannie Mae Agency Securities||$||4,396,621||2.30||%||2.33||%||1.71||%||3.36||%||9.78||%||5.7|
|Freddie Mac Agency Securities||1,744,634||2.45||2.46||1.82||2.57||9.99||6.9|
|Ginnie Mae Agency Securities||1,825,067||2.41||1.78||1.51||1.06||8.42||7.6|
|Residential mortgage loans||2,821||3.39||2.38||2.04||1.59||10.98||4.8|
|(57% of total)||7,969,143||2.36||2.23||1.69||2.66||9.51||6.4|
|Fannie Mae Agency Securities||2,614,313||2.73||2.45||1.66||3.95||7.75||40.5|
|Freddie Mac Agency Securities||2,006,330||2.77||2.49||1.70||3.21||7.85||44.0|
|Ginnie Mae Agency Securities||1,321,644||2.81||1.77||1.51||1.08||7.87||38.2|
|(43% of total)||5,942,287||2.76||2.31||1.64||3.06||7.81||41.2|
|Gross WAC (rate paid by borrowers) (c)||3.14|
Amortized cost basis represents the Company’s investment (unpaid principal balance plus unamortized investment premiums) before unrealized gains and losses. At June 30, 2015, the ratio of amortized cost basis to unpaid principal balance for the Company’s ARM holdings was 103.27. This table excludes $4 million in fixed-rate Agency Securities, residential mortgage loans and private residential mortgage pass-through securities held as collateral for structured financings.
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 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. Fully indexed WAC represents the weighted average coupon upon one or more resets using interest rate indexes and net margins as of the indicated date. Average net margins represent the weighted average levels over the underlying indexes that the portfolio can adjust to upon reset, usually subject to initial, periodic and/or lifetime caps on the amount of such adjustments during any single interest rate adjustment period and over the contractual term of the underlying loans. ARM securities with initial fixed-rate periods of five years or longer typically have either 200 or 500 basis point initial caps with 200 basis point periodic caps. Additionally, certain ARM securities held by the Company are subject only to lifetime caps or are not subject to a cap. For presentation purposes, average periodic caps in the table above reflect initial caps until after an ARM security has reached its initial reset date and lifetime caps, less the current net WAC, for ARM securities subject only to lifetime caps. At quarter-end, 66% of current-reset ARMs were subject to periodic caps averaging 1.77%; 24% were subject to initial caps averaging 3.11%; 9% were subject to lifetime caps averaging 7.65%; and 1% were not subject to a cap. All longer-to-reset ARM securities at June 30, 2015 were subject to initial caps.
Gross WAC is the weighted average interest rate of the mortgage loans underlying the indicated investments, including servicing and other fees paid by borrowers, as of the indicated balance sheet date.