UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-08896

CAPSTEAD MORTGAGE CORPORATION

(Exact name of Registrant as specified in its Charter)

Maryland		75-2027937
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
8401 North Central Expressway, Suite 800, Dallas, TX		75225
(Address of principal executive offices)		(Zip Code)

(214) 874-2323
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock ($0.01 par value)		65,070,050 as of August 6, 2009

 

 

CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2009

INDEX

PART I. — FINANCIAL INFORMATION

				Page
ITEM 1.		Financial Statements (unaudited)
Consolidated Balance Sheets — June 30, 2009 and December 31, 2008					3
Consolidated Statements of Income — Quarter and Six Months Ended June 30, 2009 and 2008					4
Consolidated Statements of Cash Flows — Six Months Ended June 30, 2009 and 2008					5
Notes to Consolidated Financial Statements					6
ITEM 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
ITEM 3.		Qualitative and Quantitative Disclosure of Market Risk			40
ITEM 4.		Controls and Procedures			40
PART II. — OTHER INFORMATION
ITEM 6.		Exhibits and Reports on Form 8-K			41
SIGNATURES					42
Computation of Ratio of Income from Continuing Operations
Certification Pursuant to Section 302(a)
Certification Pursuant to Section 302(a)
Certification Pursuant to Section 906
EX-12
EX-31.1
EX-31.2
EX-32

ITEM 1. FINANCIAL STATEMENTS

PART I. — FINANCIAL INFORMATION

CAPSTEAD MORTGAGE CORPORATION

		June 30, 2009				December 31, 2008
		(unaudited)
Assets:
Mortgage securities and similar investments ($7.2 billion pledged under repurchase arrangements)		$	7,605,202			$	7,499,249
Cash collateral receivable from interest rate swap counterparties			39,864				53,676
Interest rate swap agreements at fair value			528				—
Cash and cash equivalents			122,030				96,839
Receivables and other assets			79,837				76,481
Investments in unconsolidated affiliates			3,117				3,117
		$	7,850,578			$	7,729,362
Liabilities:
Repurchase arrangements and similar borrowings		$	6,735,304			$	6,751,500
Unsecured borrowings			103,095				103,095
Interest rate swap agreements at fair value			29,789				46,679
Common stock dividend payable			37,047				22,728
Accounts payable and accrued expenses			28,764				44,910
			6,933,999				6,968,912
Stockholders’ equity:
Preferred stock — $0.10 par value; 100,000 shares authorized:
$1.60 Cumulative Preferred Stock, Series A, 195 and 197 shares issued and outstanding at June 30, 2009 and December 31, 2008, respectively ($3,191 aggregate liquidation preference)			2,720				2,755
$1.26 Cumulative Convertible Preferred Stock, Series B, 15,819 shares issued and outstanding at June 30, 2009 and December 31, 2008 ($180,025 aggregate liquidation preference)			176,705				176,705
Common stock — $0.01 par value; 250,000 shares authorized:
63,874 and 63,135 shares issued and outstanding at June 30, 2009 and December 31, 2008, respectively			639				631
Paid-in capital			985,314				975,893
Accumulated deficit			(356,154	)			(358,155	)
Accumulated other comprehensive income (loss)			107,355				(37,379	)
			916,579				760,450
		$	7,850,578			$	7,729,362

See accompanying notes to consolidated financial statements.

CAPSTEAD MORTGAGE CORPORATION

		Quarter Ended								Six Months Ended
		June 30								June 30
		2009				2008				2009				2008
Interest income:
Mortgage securities and similar investments		$	81,062			$	97,332			$	168,946			$	203,683
Other			133				782				350				1,586
			81,195				98,114				169,296				205,269
Interest expense:
Repurchase arrangements and similar borrowings			(31,626	)			(55,019	)			(71,583	)			(124,325	)
Unsecured borrowings			(2,187	)			(2,187	)			(4,374	)			(4,374	)
			(33,813	)			(57,206	)			(75,957	)			(128,699	)
			47,382				40,908				93,339				76,570
Other revenue (expense):
Miscellaneous other revenue (expense)			(804	)			(55	)			(909	)			(1,424	)
Incentive compensation expense			(1,243	)			(2,270	)			(2,377	)			(4,520	)
General and administrative expense			(2,893	)			(1,920	)			(5,600	)			(3,881	)
			(4,940	)			(4,245	)			(8,886	)			(9,825	)
Income before equity in earnings of unconsolidated affiliates			42,442				36,663				84,453				66,745
Equity in earnings of unconsolidated affiliates			65				65				130				130
Net income		$	42,507			$	36,728			$	84,583			$	66,875
Net income available to common stockholders:
Net income		$	42,507			$	36,728			$	84,583			$	66,875
Less cash dividends paid on preferred shares			(5,061	)			(5,063	)			(10,122	)			(10,127	)
		$	37,446			$	31,665			$	74,461			$	56,748
Net income per common share:
Basic		$	0.59			$	0.59			$	1.18			$	1.13
Diluted			0.58				0.58				1.15				1.11
Cash dividends declared per share:
Common		$	0.580			$	0.590			$	1.140			$	1.110
Series A Preferred			0.400				0.400				0.800				0.800
Series B Preferred			0.315				0.315				0.630				0.630

See accompanying notes to consolidated financial statements.

CAPSTEAD MORTGAGE CORPORATION

		Six Months Ended June 30
		2009				2008
Operating activities:
Net income		$	84,583			$	66,875
Noncash items:
Amortization of investment premiums			12,135				15,032
Depreciation and other amortization			141				117
Equity-based compensation costs			597				628
Amounts related to interest rate swap agreements			736				163
Impairment charge related to commercial real estate loans			750				—
Loss from portfolio restructurings			—				1,408
Net change in receivables, other assets, accounts payable and accrued expenses			(18,006	)			10,095
Net cash provided by operating activities			80,936				94,318
Investing activities:
Purchases of mortgage securities and similar investments			(610,959	)			(2,332,970	)
Proceeds from sales of mortgage securities and similar investments			—				766,800
Principal collections on mortgage securities and similar investments			617,139				792,063
Net cash provided by (used in) investing activities			6,180				(774,107	)
Financing activities:
Proceeds from repurchase arrangements and similar borrowings			33,123,644				32,658,780
Principal payments on repurchase arrangements and similar borrowings			(33,139,834	)			(32,091,771	)
Payment on early termination of interest rate swap agreement			—				(2,275	)
Decrease (increase) in cash collateral receivable from interest rate swap counterparties			13,812				(12,110	)
Capital stock transactions			8,805				208,516
Dividends paid			(68,352	)			(45,870	)
Net cash (used in) provided by financing activities			(61,925	)			715,270
Net change in cash and cash equivalents			25,191				35,481
Cash and cash equivalents at beginning of period			96,839				6,653
Cash and cash equivalents at end of period		$	122,030			$	42,134

See accompanying notes to consolidated financial statements.

CAPSTEAD MORTGAGE CORPORATION

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 consisting almost exclusively of adjustable-rate mortgage (“ARM”) securities issued and guaranteed by government-sponsored entities, either Fannie Mae or Freddie Mac (together the “GSEs”), or by an agency of the federal government, Ginnie Mae. Agency-guaranteed mortgage securities (“Agency Securities”), carry an implied AAA rating with limited, if any, credit risk.

NOTE 2 — BASIS OF PRESENTATION

Interim Financial Reporting and Reclassifications

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 six months ended June 30, 2009 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2009. For further information refer to the audited consolidated financial statements and footnotes thereto incorporated by reference into the Company’s annual report on Form 10-K for the year ended December 31, 2008. Certain prior year amounts have been reclassified to conform to the current year presentation.

Recent Accounting Developments

In June 2008, the Financial Accounting Standards Board (“FASB”) issued Staff Position EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”). This Staff Position affects entities that accrue cash dividends on share-based payment awards during the awards’ service period when the dividends do not need to be returned if any holder forfeits an award. The FASB concluded that unvested share-based payment awards that contain rights to non-forfeitable dividends are participating securities (i.e. the holders participate in dividends with common stockholders) and must be included in computing basic and diluted earnings per share, if dilutive. FSP EITF 03-6-1 became effective for financial statements beginning January 1, 2009 and requires an entity to retroactively adjust all prior period earnings per share computations to reflect its provisions. Adopting FSP EITF 03-6-1 did not have a material impact on the Company’s consolidated financial statements.

On January 1, 2009, Capstead adopted FASB Staff Position FAS140-3 “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP140-3”). Under FSP140-3, certain seller-financed acquisitions of mortgage investments entered into after December 31, 2008 will not qualify as acquisitions if the related borrowings under repurchase arrangements are considered sufficiently linked to the acquisition transaction. Any such seller-financed acquisitions that are deemed to be sufficiently linked will generally be reported net of related financings at fair value with related changes

in fair value reported in earnings until such time as the assets are no longer financed with the sellers. No such linked acquisitions have occurred during the quarter and six months ended June 30, 2009; therefore, implementing FSP140-3 has not had any impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued three concurrent Staff Positions: (i) Staff Position No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP115-2”), (ii) Staff Position No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for an Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP157-4”) and (iii) Staff Position No. FAS 107-1 and APB 28-1, “Interim Disclosures About Fair Value of Financial Instruments” (“FSP107-1”). FSP115-2 provides additional guidance for accounting for other-than-temporary impairments on debt securities. In addition to existing guidance, under FSP115-2 an other-than-temporary impairment is deemed to exist if an entity does not expect to recover the entire amortized cost basis of a debt security. FSP115-2 provides for the bifurcation of other-than-temporary impairments into (i) amounts related to credit losses, which are recognized through earnings, and (ii) amounts related to all other factors, which are recognized as a component of Other comprehensive income (loss). Further, FSP115-2 requires certain additional disclosures for debt securities. FSP157-4 provides additional guidance for fair value measures under FAS157 in determining if the market for an asset or liability is inactive and, accordingly, if quoted market prices may not be indicative of fair value. FSP107-1 extends existing annual financial instrument fair value disclosure requirements to interim periods.

All three of these Staff Positions are effective for periods ending after June 15, 2009 and are required to be implemented concurrently. Accordingly, Capstead adopted these Staff Positions on April 1, 2009. The adoption did not have any impact on the Company’s consolidated financial statements.

In May 2009, the FASB issued statement No. 165, “Subsequent Events” (“FAS165”). FAS165 modifies the definition of what qualifies as a subsequent event — those events or transactions that occur following the balance sheet date, but before the financial statements are issued, or are available to be issued — and requires companies to disclose the date through which it has evaluated subsequent events and the basis for determining that date. FAS165 is effective for periods ending after June 15, 2009. Accordingly, Capstead adopted the standard for the quarter ended June 30, 2009. The adoption of FAS165 did not have any impact on the Company’s consolidated financial statements. In preparing the accompanying consolidated financial statements, the Company has reviewed events that have occurred after June 30, 2009, up until the time of issuance of the financial statements on August 6, 2009.

In June 2009, the FASB issued statement No. 167, “Amendments to FASB Interpretation No. 46(R)” (“FAS167”). Among other items, FAS167 responds to concerns about the application of certain key provisions of FIN 46(R), including those regarding the transparency of the involvement with variable interest entities. FAS167 is effective for calendar year companies beginning on January 1, 2010. The Company believes the potential impact of adopting FAS167 will be limited to the accounting treatment afforded its commercial mortgage investments. At this time the actual impact, if any, on the accounting for these investments and therefore the impact on the Company’s consolidated financial statements has not been determined.

NOTE 3 — EARNINGS PER COMMON SHARE

Basic earnings per common share is computed by dividing net income, after deducting preferred share dividends and adjusting for the impact of nonnvested stock awards deemed to be participating securities, by the weighted average number of common shares outstanding, calculated excluding nonvested stock awards. Diluted earnings per common share is computed by dividing net income, after deducting dividends on convertible preferred shares when such shares are antidilutive and similar adjustments for participating securities, by the weighted average number of common shares and common share

equivalents outstanding, giving effect to equity awards and convertible preferred shares, when such awards and shares are dilutive. For calculation purposes the Series A and B preferred shares are considered dilutive whenever basic earnings per common share exceeds each Series’ dividend divided by the conversion rate applicable for that period. Nonvested stock awards that are deemed participating securities are included in the calculation of diluted earnings per 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 earnings per common share were as follows (dollars in thousands, except per share amounts):

		Quarter Ended								Six Months Ended
		June 30								June 30
		2009				2008				2009				2008
Numerator for basic earnings per common share:
Net income		$	42,507			$	36,728			$	84,583			$	66,875
Less:
Series A and B preferred share dividends			(5,061	)			(5,063	)			(10,122	)			(10,127	)
Basic earnings impact of nonvested stock awards			(120	)			(193	)			(357	)			(385	)
		$	37,326			$	31,472			$	74,104			$	56,363
Weighted average common shares outstanding:
Total average shares outstanding			63,486				53,815				63,323				50,175
Less:
Average nonvested stock awards outstanding			(370	)			(362	)			(388	)			(372	)
			63,116				53,453				62,935				49,803
Basic earnings per common share		$	0.59			$	0.59			$	1.18			$	1.13
Numerator for diluted earnings per common share:
Net income		$	42,507			$	36,728			$	84,583			$	66,875
Less:
Diluted earnings impact of nonvested stock awards			(120	)			(193	)			(357	)			(385	)
		$	42,387			$	36,535			$	84,226			$	66,490
Denominator for diluted earnings per common share:
Weighted average common shares outstanding			63,116				53,453				62,935				49,803
Net effect of dilutive option awards			96				160				97				215
Net effect of dilutive convertible preferred shares			9,928				9,829				9,929				9,824
			73,140				63,442				72,961				59,842
Diluted earnings per common share		$	0.58			$	0.58			$	1.15			$	1.11

Potentially dilutive securities excluded from the calculation of diluted earnings per common share under the treasury stock method were as follows (in thousands):

		Quarter Ended								Six Months Ended
		June 30								June 30
		2009				2008				2009				2008
Antidilutive equity awards:
Shares issuable under option awards			40				40				70				10
Nonvested stock awards			118				—				—				—

NOTE 4 — MORTGAGE SECURITIES AND SIMILAR INVESTMENTS

Mortgage securities and similar investments and related weighted average coupon rates and yields classified by collateral type and interest rate characteristics were as follows (dollars in thousands):

						Investment
		Principal				Premiums								Carrying				Net				Average
		Balance				(Discounts)				Basis				Amount(a)				WAC(b)				Yield(b)
June 30, 2009
Agency Securities:
Fannie Mae/Freddie Mac:
Fixed-rate		$	7,971			$	25			$	7,996			$	8,013				6.69	%			6.16	%
ARMs			6,945,668				88,914				7,034,582				7,166,480				4.74				4.35
Ginnie Mae ARMs			363,779				1,941				365,720				370,559				4.45				4.32
			7,317,418				90,880				7,408,298				7,545,052				4.73				4.35
Residential mortgage loans:
Fixed-rate			4,525				6				4,531				4,531				7.09				6.91
ARMs			8,618				77				8,695				8,695				4.92				5.21
			13,143				83				13,226				13,226				5.66				5.81
Commercial real estate loans			44,110				—				44,110				43,079				—				—
Collateral for structured financings			3,782				63				3,845				3,845				8.13				7.78
		$	7,378,453			$	91,026			$	7,469,479			$	7,605,202				4.70				4.33
December 31, 2008
Agency Securities:
Fannie Mae/Freddie Mac:
Fixed-rate		$	9,991			$	31			$	10,022			$	10,041				6.64	%			6.56	%
ARMs			6,928,385				90,942				7,019,327				7,029,002				5.29				4.90
Ginnie Mae ARMs			394,909				2,056				396,965				397,443				4.94				4.81
			7,333,285				93,029				7,426,314				7,436,486				5.27				4.90
Residential mortgage loans:
Fixed-rate			5,880				(8	)			5,872				5,872				7.16				7.09
ARMs			9,053				79				9,132				9,132				5.58				5.90
			14,933				71				15,004				15,004				6.20				6.36
Commercial real estate loans			43,444				—				43,444				43,163				7.03				8.48
Collateral for structured financings			4,523				73				4,596				4,596				8.09				7.79
		$	7,396,185			$	93,173			$	7,489,358			$	7,499,249				5.29				4.92

(a)		Includes unrealized gains and losses for securities classified as available-for-sale, if applicable (see NOTE 9) and an allowance for possible loan losses on commercial real estate loans totaling $1.0 million and $281,000 at June 30, 2009 and December 31, 2008, respectively.
(b)		Net WAC, or weighted average coupon, is presented net of servicing and other fees as of the indicated balance sheet date and is calculated excluding nonperforming investments. Average yield is presented for the quarter then ended, calculated including the amortization of investment premiums (discounts) and excluding unrealized gains and losses.

Agency Securities carry an implied AAA rating and therefore limited credit risk. Residential mortgage loans held by the Company were originated prior to 1995 when Capstead operated a mortgage conduit and the related credit risk is borne by the Company. Commercial real estate loans are subordinate loans that carry credit risk associated with specific commercial real estate collateral. Collateral for structured financings consists of private residential mortgage pass-through securities obtained through the above-mentioned mortgage conduit that are pledged to secure securitizations. The related credit risk is borne by bondholders of the securitizations. The maturity of mortgage securities is directly affected by the rate of

principal prepayments on the underlying mortgage loans. Consequently, the actual maturity of the Company’s mortgage securities will be significantly shorter than the portfolio’s 295 month weighted average contractual maturity.

Fixed-rate investments are generally residential mortgage loans or Agency Securities backed by mortgage loans with fixed rates of interest. Adjustable-rate investments generally are ARM Agency Securities 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 either (i) adjust annually based on specified margins over the one-year Constant Maturity U.S. Treasury Note Rate (“CMT”) or the one-year London interbank offered rate (“LIBOR”), (ii) adjust semiannually based on specified margins over six-month LIBOR, or (iii) adjust monthly based on specified margins over indexes such as one-month LIBOR or 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 on the amount of such adjustments during any single interest rate adjustment period and over the contractual term of the loans.

The Company classifies its ARM securities based on each security’s average number of months until coupon reset (“months-to-roll”). Current-reset ARM securities have a months-to-roll of 18 months or less while longer-to-reset ARM securities have a months-to-roll of greater than 18 months. The average months-to-roll for the $5.05 billion (basis) in current-reset ARM securities held by the Company as of June 30, 2009 was 4.9 months compared to 30.7 months for the Company’s $2.36 billion (basis) in longer-to-reset ARM securities.

Commercial real estate loans at June 30, 2009 consisted of $5.7 million in subordinated loans to a Dallas, Texas-based townhome developer expected to be repaid primarily through unit sales and $38.4 million in subordinated loans collateralized by the Four Seasons hotel in Nevis, West Indies that matured October 9, 2008 and one week later was damaged by Hurricane Omar. The Nevis property has wind and business interruption insurance coverage, which together with related reserves, should be sufficient to repair the hotel for reopening in early 2010. In January 2009 the Company filed suit against the loan servicer and a lien holder subordinate to Capstead to enforce the Company’s rights under the loan documents including, among other items, the right to be named the controlling holder representing the lending group in reaching a resolution for the financing of this property. Included in Receivables and other assets is $808,000 in accrued interest associated with these investments and $855,000 of interest was recognized during the fourth quarter of 2008 after it was determined that impairment conditions existed. In light of deteriorating commercial real estate market conditions and the past due status of these loans, no interest was recognized during the quarter and six months ended June 30, 2009. Additionally, during the quarter ended June 30, 2009 the Company recorded in Miscellaneous other revenue (expense) a $750,000 impairment charge primarily as a result of slow sales of units collateralizing the townhome development loans. With this charge, the Company’s allowance for possible loan losses has been increased to $1.0 million. Based on currently available information, no impairment charges were deemed appropriate at June 30, 2009 for the Nevis loan.

NOTE 5 — INVESTMENTS IN UNCONSOLIDATED AFFILIATES

To facilitate the issuance of Unsecured borrowings, in September and December 2005 and in September 2006 Capstead formed and capitalized a series of three Delaware statutory trusts through the issuance to the Company of the trusts’ common securities totaling $3.1 million (see NOTE 7). The Company’s equity in the earnings of the trusts consists solely of the common trust securities’ pro rata share in interest accruing on Unsecured borrowings issued to the trusts.

NOTE 6 — REPURCHASE ARRANGEMENTS AND SIMILAR
BORROWINGS, INCLUDING RELATED HEDGING ACTIVITY

Capstead generally pledges its Mortgage securities and similar investments as collateral under uncommitted repurchase arrangements with commercial banks and other financial institutions, the terms and conditions of which are negotiated on a transaction-by-transaction basis when each borrowing is initiated or renewed. Related borrowing rates are generally based on prevailing rates corresponding to the terms of the borrowings. Amounts available to be borrowed are dependent upon the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, credit quality and liquidity conditions within the banking, mortgage finance and real estate industries.

In response to declines in fair value of pledged securities, lenders may require the Company to post additional collateral or pay down borrowings to re-establish agreed upon collateral requirements, referred to as margin calls. The maturity of outstanding structured financings is directly affected by the rate of principal prepayments on the related mortgage pass-through securities pledged as collateral. In addition, structured financings are currently subject to redemption by the residual bondholders.

Repurchase arrangements and similar borrowings, classified by type of collateral and maturities, and related weighted average interest rates were as follows (dollars in thousands):

		June 30, 2009								December 31, 2008
		Borrowings				Average				Borrowings				Average
Collateral Type		Outstanding				Rate *				Outstanding				Rate *
Borrowings with maturities of 30 days or less:
Agency Securities		$	6,399,549				0.65	%		$	5,179,137				2.74	%
Borrowings with maturities greater than 30 days:
Agency Securities (31 to 90 days)			331,910				5.10				835,628				2.87
Agency Securities (91 to 360 days)			—				—				732,139				5.13
			331,910				5.10				1,567,767				3.93
Similar borrowings:
Collateral for structured financings			3,845				8.13				4,596				8.09
		$	6,735,304				0.87			$	6,751,500				3.02

*		Average rate is presented as of the indicated balance sheet date and does not include the effects of interest rate swap agreements held as cash flow hedges on a designated portion of 30- to 90-day borrowings (see below). After giving effect to these cash flow hedges, the average rate was 1.73% and 3.55% as of June 30, 2009 and December 31, 2008, respectively.

Prior to the fourth quarter of 2007, Capstead routinely made use of longer-dated repurchase arrangements to effectively lock in financing spreads on a portion of its investments in longer-to-reset ARM Agency Securities for a significant portion of the fixed-rate terms of these investments. As of June 30, 2009, remaining longer-term committed borrowings consisted of a series of repurchase arrangements totaling $557 million at an average interest rate of 5.17% maturing within the next two months. Late in 2007 the Company began using two-year term, one- and three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements for this purpose in lieu of longer-dated repurchase arrangements. As of June 30, 2009, the Company’s swap positions consisted of 19 swap agreements with three large commercial banks with notional amounts totaling $2.40 billion at average fixed rates of 3.00% and average remaining terms of nine months, including agreements with notional amounts totaling $900 million with average fixed rates of 4.03% that terminate in November and December 2009; $800 million with average fixed rates of 2.84% that terminate during the quarter ended March 31, 2010; $200 million with average fixed rates of 3.17% that terminate during the quarter ended June 30, 2010; and $500 million with average fixed rates of 1.33% that terminate between January and May 2011.

All swap agreements have been designated as cash flow hedges of the variability of the underlying benchmark interest rate of certain current and forecasted 30- to 90-day repurchase arrangements. This hedge relationship in effect establishes a relatively stable fixed rate on the designated borrowings with the variable-rate payments to be received on the swap agreements providing an offset to interest accruing on the designated borrowings, leaving the fixed-rate payments to be paid on the swap agreements as the Company’s effective borrowing rate, subject to certain adjustments including the effects of measured hedge ineffectiveness and the spread between variable rates on the swap agreements and related actual borrowing rates. Disclosures related to these Derivatives were as follows as of and for the indicated periods (in thousands):

		Balance Sheet		June 30,				December 31,
		Location		2009				2008
Balance sheet-related
Derivatives designated as cash flow hedging instruments:
Interest rate swap agreements at fair value — assets (c)		(a)		$	528			$	—
Interest rate swap agreements at fair value — (liabilities) (c)		(a)			(29,789	)			(46,679	)
Related net interest payable		(b)			(16,263	)			(12,909	)
				$	(45,524	)		$	(59,588	)

		Location of
		Gain or
		(Loss)
		Recognized		Quarter Ended								Six Months Ended
		in		June 30								June 30
		Net Income		2009				2008				2009				2008
Income statement-related
Components of effect on Interest expense:		(a)
Amount of gain (loss) reclassified from AOCI:
Effective portion of active positions				$	(14,303	)		$	(3,077	)		$	(26,580	)		$	(3,262	)
Effective portion of terminated positions		(d)			(303	)			(188	)			(559	)			(249	)
					(14,606	)			(3,265	)			(27,139	)			(3,511	)
Amount of gain (loss) recognized (ineffective portion)					99				290				585				910
(Increase) decrease in Interest expense					(14,507	)			(2,975	)			(26,554	)			(2,601	)
Holding gains on interest rate swap agreements realized prior to designation as cash flow hedge		(e)			—				—				—				81
(Decrease) increase in Net income as a result of the use of interest rate swap agreements				$	(14,507	)		$	(2,975	)		$	(26,554	)		$	(2,520	)
Other comprehensive income-related:
Amount of gain (loss) recognized in other comprehensive income (loss) (effective portion)				$	(4,721	)		$	24,623			$	(8,987	)		$	(5,380	)

(a)		Included under this caption on the face of the balance sheet or statement of income.
(b)		Included in Accounts payable and accrued expenses on the face of the balance sheet.
(c)		The estimated amount of unrealized losses that will be recognized in the statement of income over the next twelve months in the form of fixed and variable rate swap payments in excess of current market rates totaled $31.3 million as of June 30, 2009, based on market conditions in effect on that date.
(d)		In March 2008 a swap agreement with a $100 million notional amount was terminated for a realized loss of $2.3 million which is being amortized to earnings over the original two-year term of the Derivative (through January 2010).
(e)		Included in Miscellaneous other revenue (expense) on the face of the statement of income.

The Company’s interest rate swap agreements are measured at fair value on a recurring basis primarily using Level Two Inputs in accordance with the provisions of Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS157”), as amended. In determining fair value

estimates for these agreements, the Company utilizes the standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts 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 as applicable in determining the fair value of its interest rate swap agreements. 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 of these agreements.

NOTE 7 — UNSECURED BORROWINGS

Unsecured borrowings consist of 30-year junior subordinated notes issued in 2006 and 2005 to three special-purpose, statutory trusts. These unconsolidated affiliates of the Company were formed to issue $3.1 million of the trusts’ common securities to Capstead and to privately place $100 million of preferred securities with unrelated third party investors. Included in Receivables and other assets are $2.7 million in remaining issue costs associated with these transactions. Note balances and related weighted average interest rates as of June 30, 2009 and December 31, 2008 (calculated including issue cost amortization) were as follows (dollars in thousands):

		Borrowings				Average
		Outstanding				Rate
Junior subordinated notes:
Capstead Mortgage Trust I		$	36,083				8.31	%
Capstead Mortgage Trust II			41,238				8.46
Capstead Mortgage Trust III			25,774				8.78
		$	103,095				8.49

The junior subordinated notes pay interest to the trusts quarterly calculated at fixed rates of 8.19% to 8.685% for ten years from issuance and subsequently at prevailing three-month LIBOR rates plus 3.30% to 3.50% for 20 years, reset quarterly. The trusts remit dividends pro rata to the common and preferred trust securities based on the same terms as the subordinated notes provided that payments on the trusts’ common securities are subordinate to payments on the related preferred securities. The Capstead Mortgage Trust I notes and trust securities mature in October 2035 and are redeemable, in whole or in part, without penalty, at the Company’s option anytime on or after October 30, 2010. The Capstead Mortgage Trust II notes and trust securities mature in December 2035 and are redeemable, in whole or in part, without penalty, at the Company’s option anytime on or after December 15, 2015. The Capstead Mortgage Trust III notes and trust securities mature in September 2036 and are redeemable, in whole or in part, without penalty, at the Company’s option anytime on or after September 15, 2016. The weighted average effective interest rate for Unsecured borrowings (calculated including issue cost amortization) was 8.49% during the quarter ended June 30, 2009.

NOTE 8 — COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) is net income plus other comprehensive income (loss). Other comprehensive income (loss) currently consists of the change in unrealized gain on mortgage securities classified as available-for-sale and amounts related to Derivatives held as cash flow hedges. As of June 30, 2009, the Accumulated other comprehensive income (loss) component of Stockholders’ equity consisted of $136.8 million in net unrealized gains on mortgage securities held available-for-sale, $28.7 million in net unrealized losses on Derivatives held as cash flow hedges and the $723,000 amortized balance of a realized loss offset by $48,000 in realized gains, both related to terminated cash flow hedges.

The following provides information regarding the components of comprehensive income (loss) (in thousands):

		Quarter Ended								Six Months Ended
		June 30								June 30
		2009				2008				2009				2008
Net income		$	42,507			$	36,728			$	84,583			$	66,875
Other comprehensive income (loss):
Amounts related to available-for-sale securities:
Reclassification adjustments for amounts included in net income			—				—				—				1,408
Change in net unrealized gains			61,017				10,972				126,582				507
Amounts related to cash flow hedges:
Change in net unrealized losses			(4,721	)			24,623				(8,987	)			(3,105	)
Early termination of interest rate swap agreement			—				—				—				(2,275	)
Reclassification adjustment for amounts included in net income			14,606				3,261				27,139				3,507
Other comprehensive income (loss)			70,902				38,856				144,734				42
Comprehensive income (loss)		$	113,409			$	75,584			$	229,317			$	66,917

NOTE 9 — DISCLOSURES REGARDING FAIR VALUES OF FINANCIAL INSTRUMENTS

The following tables and related discussion provide fair value disclosures as of the indicated balance sheet dates for Capstead’s financial assets and liabilities, most of which 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. Excluded from these disclosures are financial instruments for which the Company’s cost basis is deemed to approximate fair value due primarily to the short duration of these instruments, including Cash and cash equivalents, Cash collateral receivable from interest rate swap counterparties, receivables, payables and borrowings under repurchase arrangements with initial terms of 90 days or less.

The Company’s holdings of residential mortgage securities, nearly all of which are classified as held available-for-sale, are measured at fair value on a recurring basis using Level Two Inputs in accordance with the provisions of SFAS157. In determining fair value estimates for mortgage securities the Company considers recent trading activity for similar investments and pricing levels indicated by lenders in connection with designating collateral for repurchase arrangements, provided such pricing levels are considered indicative of actual market clearing transactions. These fair value estimates 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.

Fair values for commercial real estate loans are estimated using valuation techniques that involve uncertainties and are affected by assumptions used and judgments made regarding risk characteristics, discount rates, future cash flows, future loss expectations, and other factors. The Company discounted future cash flows in estimating fair value of its commercial loans at 25%. Fair values of borrowings under repurchase arrangements with initial terms of greater than 90 days and Unsecured borrowings are estimated based on offer prices for similar financial instruments or market positions (Level Two Inputs). See NOTE 6 for information relative to the valuation of interest rate swap agreements.

Fair value disclosures related to financial instruments other than mortgage securities were as follows (in thousands):

		June 30, 2009								December 31, 2008
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
Financial Assets:
Residential mortgage loans		$	13,226			$	13,300			$	15,004			$	15,000
Commercial real estate loans			43,079				23,800				43,163				25,500
Interest rate swap agreements			528				528				—				—
Financial Liabilities:
Repurchase arrangements with initial terms of greater than 90 days			556,980				560,100				1,127,420				1,142,900
Unsecured borrowings			103,095				93,600				103,095				85,900
Interest rate swap agreements			29,789				29,789				46,679				46,679

Fair value disclosures for mortgage securities were as follows (in thousands):

						Gross Unrealized
		Basis				Gains				Losses				Fair Value
As of June 30, 2009
Agency Securities classified as available-for-sale		$	7,400,509			$	138,986			$	2,232			$	7,537,263
Mortgage securities classified as held-to-maturity			11,634				436				—				12,070
As of December 31, 2008
Agency Securities classified as available-for-sale		$	7,416,520			$	49,904			$	39,732			$	7,426,692
Mortgage securities classified as held-to-maturity			14,390				332				—				14,722

Additional required disclosures for mortgage securities in an unrealized loss position were as follows (in thousands):

		June 30, 2009								December 31, 2008
		Fair				Unrealized				Fair				Unrealized
		Value				Loss				Value				Loss
Securities in an unrealized loss position:
One year or greater		$	326,338			$	1,275			$	157,675			$	2,454
Less than one year			511,874				957				2,762,619				37,278
		$	838,212			$	2,232			$	2,920,294			$	39,732

Managing a leveraged portfolio of primarily ARM Agency Securities is the core focus of Capstead’s investment strategy and management expects these securities will be held until payoff absent a major shift in the Company’s investment focus. Declines in fair value caused by increases in interest rates are typically modest for investments in relatively short-duration ARM Agency Securities compared to investments in longer-duration, fixed-rate assets. These declines are generally recoverable in a relatively short period of time as the coupon interest rates on the underlying mortgage loans reset to rates more reflective of the then current interest rate environment allowing for the potential recovery of financing spreads diminished during periods of rising interest rates.

From a credit risk perspective, the real or implied federal government guarantee associated with Agency Securities, particularly in light of the September 2008 conservatorship of the GSEs and other government support for these entities, helps ensure that fluctuations in value due to credit risk associated with these securities will be limited. Additionally, this support for the GSEs and other government actions to support the global financial system and improve market conditions has dramatically improved market

liquidity for leveraged holders of Agency Securities compared to conditions existing late in 2008 in the aftermath of the Lehman Brothers Holdings, Inc. bankruptcy. Given that (a) any existing unrealized losses on mortgage securities held by the Company are not attributable to credit risk, (b) the Company typically holds its investments to maturity, and (c) it is more likely than not that the Company will not be required to sell any of its investments, none of these investments are considered other-than-temporarily impaired at June 30, 2009.

During the quarter ended March 31, 2008 the Company sold Agency Securities classified as available-for-sale with a cost basis of $768 million recognizing a loss of $1.4 million (gross realized losses of $2.7 million, and gross realized gains of $1.3 million) included in Miscellaneous other revenue (expense). No asset sales occurred during the quarter and six months ended June 30, 2009.

NOTE 10 — COMPENSATION PROGRAMS

The compensation committee of Capstead’s board of directors administers all compensation programs for officers and employees including salaries, annual incentive compensation and long-term equity-based awards, as well as other benefit programs.

Performance-based Cash Compensation Program to Augment Base Salaries

To augment base salaries of certain executive officers, in 2008 the committee implemented a performance-based cash compensation program that provides for payments equal to the per share dividend declared on the Company’s common stock multiplied by a notional amount of non-vesting or “phantom” common shares (“Dividend Equivalents”). Dividend Equivalents are not attached to any stock or option awards and only have the right to receive the same cash distributions as the Company’s common stockholders are entitled to receive during the term of the grants, subject to certain conditions, including continuous service. In implementing this program, initial Dividend Equivalents for 225,000 phantom common shares with terms ending on July 1, 2012 were granted to certain executive officers in 2008. On July 14, 2009, these officers received additional grants for 225,000 phantom common shares with terms ending July 1, 2012. During the quarter and six months ended June 30, 2009, the Company recognized in General and administrative expense $131,000 and $257,000 related to this program, respectively.

Annual Incentive Compensation

To provide officers and employees with an appropriate performance-based annual incentive compensation opportunity, each year the committee approves an incentive formula to create an incentive pool equal to a percentage participation in the Company’s earnings in excess of a pre-established performance threshold. The committee has complete discretion with respect to the amount to be distributed from the pool, including its allocation between executive officers and other employees. Approved distributions are typically made subsequent to year-end. The committee used its discretion to limit the total amount of annual incentive compensation awarded for the year ended December 31, 2008 to $6 million.

For 2009 the committee modified the formula for determining the incentive pool and established a guideline for determining the maximum amount available to be paid in any single year equal to 50 basis points multiplied by average long-term investment capital, as defined. For purposes of the 2009 calculation, the incentive pool will equal a 10% participation in “annual earnings” (defined as Net income excluding Incentive compensation expense, any gain or loss from portfolio restructurings and interest on Unsecured borrowings, net of equity in the earnings of related statutory trusts reflected in the balance sheet as Investments in unconsolidated affiliates) in excess of a benchmark amount based on “average long-term investment capital” (defined as Unsecured borrowings, net of related investments in statutory trusts and average Stockholders’ equity, excluding Accumulated other comprehensive income (loss), incentive compensation accruals, any gain or loss from portfolio restructurings and interest on Unsecured

borrowings, net of equity in the earnings of related statutory trusts) multiplied by the greater of 8.00% or the average 10-year U.S. Treasury rate plus 200 basis points. During the quarter and six months ended June 30, 2009, the Company recognized Incentive compensation expense of $1,243,000 and $2,377,000, respectively; the accrual for which is included in Accounts payable and accrued expenses.

Long-term Equity-based Awards

The Company sponsors equity-based award plans to provide for the issuance of stock awards, option awards and other long-term equity-based awards to directors and employees (collectively, the “Plans”). As of June 30, 2009, the Plans had 1,608,549 common shares remaining available for future issuance.

Service-based stock awards issued to directors and employees that vest in annual installments in 2009 and future years, subject to certain restrictions (principally continuous service), were as follows as of June 30, 2009:

						Total
Year of		Grant Date				Original				Shares Vesting In:
Grant		Fair Value				Grants				2009				2010				2011				2012				2013				2014
2005		$	7.86				172,600				35,100				—				—				—				—				—
2006			8.06				218,957				48,126				44,374				44,374				—				—				—
2007			12.93				156,000				24,672				23,672				23,665				23,665				23,663				23,663
2008			12.87				6,000				6,000				—				—				—				—				—
2009			11.39				6,000				—				6,000				—				—				—				—

In 2008, the Company began implementing a performance-based stock award program in lieu of its previous practice of issuing service-based awards to employees. In December 2008 the first grants totaling 140,658 common shares were issued to employees (grant date fair value $10.18). The first 50% of these awards vest provided certain performance criteria pertaining to a three-year measurement period ending December 31, 2011 are met. The remaining 50% vests provided performance criteria pertaining to a three-year measurement period ending December 31, 2012 are met. If the performance criteria are not met at the end of a three-year measurement period, vesting will be deferred and a new three-year measurement period will be established to include the subsequent year, up to and including the year 2015. Any remaining unvested awards will expire if the performance criteria for the final three-year measurement period ending December 31, 2015 are not met. The performance criteria establishes an annualized threshold return on the Company’s long-term investment capital, subject to certain adjustments, of the greater of 8.0% or the average 10-year U.S. Treasury rate plus 200 basis points that must be exceeded for the awards to vest.

Stock award activity for the six months ended June 30, 2009 is summarized below:

						Weighted Average
		Number of				Grant Date
		Shares				Fair Value
Stock awards outstanding at December 31, 2008			479,132			$	10.30
Grants			6,000				11.39
Forfeitures			(17,500	)			9.19
Vested			(113,898	)			9.39
Stock awards outstanding at June 30, 2009			353,734				10.66

Option awards currently outstanding have contractual terms and vesting requirements at the grant date of up to ten years and generally have been issued with strike prices equal to the quoted market prices of the Company’s common shares on the date of grant. The fair value of each option award is estimated on the date of grant using a Black-Scholes option pricing model. The Company estimates option exercises,

expected holding periods and forfeitures based on past experience and current expectations for option performance and employee or director attrition. Risk-free rates are based on market rates for the expected life of the option. Expected dividends are based on historical experience and expectations for future performance. Expected volatility factors are based on historical experience.

During the quarter and six months ended June 30, 2009, the Company recognized in General and administrative expense $265,000 and $562,000 related to stock awards, respectively. Unrecognized compensation expense for unvested stock awards totaled $3.2 million as of June 30, 2009, to be expensed over a weighted average period of 2.2 years.

Stock options issued to directors and employees that vest in annual installments in 2009 and future years, subject to certain restrictions (principally continuous service), were as follows as of June 30, 2009:

Year of		Grant Date				Strike				Total				Remaining Shares Vesting In:
Grant		Fair Value *				Price				Original Grants				2009				2010				2011
2005		$	0.61			$	7.85				430,000				71,875				—				—
2006			0.78				7.43				258,000				36,000				36,000				—
2007			0.89				10.46				220,500				40,750				40,750				40,750
2008			2.08				12.87				30,000				30,000				—				—
2009			1.52				11.69				30,000				—				30,000				—

*		Based on volatility factors of 27%, 31%, 27%, 50% and 51% for years 2005, 2006, 2007, 2008 and 2009, respectively; dividend yields of 10% for years 2005 through 2007, 12% for 2008 and 14% for 2009; risk-free rates of 3.76%, 4.91%, 4.60%, 2.91% and 1.70% for years 2005, 2006, 2007, 2008 and 2009, respectively; and four year expected terms.

Option award activity for the six months ended June 30, 2009 is summarized below:

		Number of				Weighted Average
		Shares				Exercise Price
Option awards outstanding at December 31, 2008			555,750			$	9.12
Grants			30,000				11.69
Forfeitures			(43,750	)			8.43
Exercises			(89,375	)			7.91
Option awards outstanding at June 30, 2009			452,625				9.59

Exercisable option awards outstanding as of June 30, 2009 totaled 305,125 common shares and had a weighted average remaining contractual term of seven years, an average exercise price of $9.40 and aggregate intrinsic value of $1,031,000. The total intrinsic value of option awards exercised during the quarter and six months ended June 30, 2009 was $170,000 and $353,000, respectively. During the quarter and six months ended June 30, 2009, the Company recognized in General and administrative expense $4,000 and $35,000 related to option awards, respectively. Unrecognized compensation costs for unvested option awards totaled $72,000 as of June 30, 2009, to be expensed over a weighted average period of 1.0 years.

Other Benefit Programs

Capstead sponsors a qualified defined contribution retirement plan for all employees and a nonqualified deferred compensation plan for certain of its officers. In general the Company matches up to 50% of a participant’s voluntary contribution up to a maximum of 6% of a participant’s compensation and discretionary contributions of up to another 3% of compensation regardless of participation in the plans. Company contributions are subject to certain vesting requirements. During the quarter and six months ended June 30, 2009, the Company recognized in General and administrative expense $85,000 and $195,000 related to contributions to these plans, respectively.

NOTE 11 — NET INTEREST INCOME ANALYSIS

The following summarizes interest income, interest expense and weighted average interest rates as well as related changes in interest income and interest expense due to changes in interest rates versus changes in volume (dollars in thousands):

		Quarter Ended June 30
		2009								2008								Related Changes in
						Average								Average
		Amount				Rate				Amount				Rate				Rate*				Volume*				Total*
Interest income:
Mortgage securities and similar investments		$	81,062				4.33	%		$	97,332				5.30	%		$	(18,115	)		$	1,845			$	(16,270	)
Other			133				0.43				782				2.74				(713	)			64				(649	)
			81,195				4.27				98,114				5.26				(18,828	)			1,909				(16,919	)
Interest expense:
Repurchase arrangements and similar borrowings		$	(31,626	)			1.86			$	(55,019	)			3.25			$	(23,415	)		$	22			$	(23,393	)
Unsecured borrowings			(2,187	)			8.49				(2,187	)			8.49				—				—				—
			(33,813	)			1.96				(57,206	)			3.33				(23,415	)			22				(23,393	)
		$	47,382				2.31			$	40,908				1.93			$	4,587			$	1,887			$	6,474