UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A

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

For the quarterly period ended: March 31, 2008

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

For the transition period from                      to                     

CAPSTEAD MORTGAGE CORPORATION

(Exact name of Registrant as specified in its Charter)

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

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

Indicate by check mark whether the Registrant (1) has filed all documents and 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 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. (Check one):

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 last practicable date.

Common Stock ($0.01 par value)		53,599,208 as of May 12, 2008

 

 

CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q/A
FOR THE QUARTER ENDED MARCH 31, 2008

INDEX

		Page
PART I. — FINANCIAL INFORMATION
EXPLANATORY NOTE — RECLASSIFYING RESTATEMENT			3
ITEM 1. Financial Statements (unaudited)
Consolidated Balance Sheets — March 31, 2008 and December 31, 2007			5
Consolidated Statements of Income — Quarter Ended March 31, 2008 and 2007			6
Consolidated Statements of Cash Flows —Quarter Ended March 31, 2008 and 2007			7
Notes to Consolidated Financial Statements			8
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 4. Submission of Matters to a Vote of Security Holders			41
ITEM 6. Exhibits and Reports on Form 8-K			42
SIGNATURES			43
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

EXPLANATORY NOTE — RECLASSIFYING RESTATEMENT

After receiving a request from the Securities and Exchange Commission (the “Commission”) in a comment letter dated December 18, 2008, management of Capstead Mortgage Corporation (the “Company”) concluded that the Company’s previously filed consolidated statements of operations for the three years ending December 31, 2007 and for the periods included in its Forms 10-Q filed in 2008, should be reclassified and restated to include interest expense from unsecured borrowings with interest expense from repurchase arrangements and similar borrowings in arriving at net interest margin rather than including interest expense from unsecured borrowings as a component of other revenue (expense). Accordingly, the consolidated statements of operations included in this Form 10-Q/A have been restated to reflect interest income from all sources under the caption “Interest income” and interest expense from all sources under the caption “Interest expense.” The resulting net interest margin subtotal no longer provides readers of the Company’s consolidated financial statements with solely the net interest margin earned on its portfolio of mortgage securities and similar investments after directly-related secured borrowings, but a more all-inclusive measure of net interest margin that includes interest income earned on overnight cash investments and cash margin balances and interest costs associated with the unsecured borrowings.

The reclassifications contained in these restatements do not change the Company’s previously reported net income, earnings per share or stockholders’ equity for any of the aforementioned periods. In addition, the restatements do not impact the Company’s consolidated balance sheets, statements of stockholders’ equity or cash flows for the indicated periods.

The impact of the reclassifications in the consolidated statements of income for the three months ended March 31, 2008 and 2007 is summarized as follows:

		Quarter Ended March 31
		2008				2007
Interest income:
As previously reported		$	106,351			$	72,142
Reclassification			804				62
As amended		$	107,155			$	72,204
Interest expense:
As previously reported		$	(69,306	)		$	(63,589	)
Reclassification			(2,187	)			(2,187	)
As amended		$	(71,493	)		$	(65,776	)
Net interest income:
As previously reported		$	37,045			$	8,553
Reclassification			(1,383	)			(2,125	)
As amended		$	35,662			$	6,428
Other revenue (expense):
As previously reported		$	(6,963	)		$	(2,990	)
Reclassification			1,383				2,125
As amended		$	(5,580	)		$	(865	)
Impact on net income from these restatements		$	—			$	—

Management believes its previous presentation was based on a reasonable interpretation of the applicable rules of the Commission, and as such, management believes the restatement has had no impact on the conclusion reached at December 31, 2007 that the design and operation of the Company’s disclosure controls and procedures were effective. This Form 10-Q/A has been signed as of the current date and all certifications of the Company’s Chief Executive Officer and Chief Financial Officer are given as of a current date. Accordingly, this Form 10-Q/A should be read in conjunction with the Company’s filings made with the Commission subsequent to the March 5, 2008 filing of the original Form 10-K for the year ended December 31, 2007.

Management and the Audit Committee of the Board of Directors have discussed these matters with the Company’s independent registered public accounting firm, Ernst & Young, LLP.

For the convenience of the reader, this Form 10-Q/A sets forth the Company’s original Form 10-Q as filed with the SEC on May 12, 2008 (the “Original 10-Q”) in its entirety, as amended by, and to reflect, the reclassifications required by this restatement. No other attempt has been made in this Form 10-Q/A to update other disclosures presented in the Original 10-Q, except as required to reflect the effects of the restatement. This Form 10-Q/A does not reflect events occurring after the filing of the Original 10-Q or modify or update those disclosures, including the exhibits to the Original 10-Q affected by subsequent events.

ITEM 1. FINANCIAL STATEMENTS

PART I. — FINANCIAL INFORMATION

CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)

		March 31, 2008				December 31, 2007
		(unaudited)
Assets:
Mortgage securities and similar investments ($7.2 billion pledged under repurchase arrangements)		$	7,397,593			$	7,108,719
Investments in unconsolidated affiliates			3,117				3,117
Receivables and other assets			140,578				90,437
Cash and cash equivalents			101,355				6,653
		$	7,642,643			$	7,208,926
Liabilities:
Repurchase arrangements and similar borrowings		$	6,796,290			$	6,500,362
Unsecured borrowings			103,095				103,095
Interest rate swap agreements at fair value			30,052				2,384
Common stock dividend payable			25,957				9,786
Accounts payable and accrued expenses			34,515				32,382
			6,989,909				6,648,009
Stockholders’ equity:
Preferred stock — $0.10 par value; 100,000 shares authorized:
$1.60 Cumulative Preferred Stock, Series A, 202 shares issued and outstanding at March 31, 2008 and December 31, 2007 ($3,315 aggregate liquidation preference)			2,826				2,828
$1.26 Cumulative Convertible Preferred Stock, Series B, 15,819 shares issued and outstanding at March 31, 2008 and December 31, 2007 ($180,025 aggregate liquidation preference)			176,705				176,705
Common stock — $0.01 par value; 100,000 shares authorized:
49,918 and 40,819 shares issued and outstanding at March 31, 2008 and December 31, 2007, respectively			499				408
Paid-in capital			832,712				702,170
Accumulated deficit			(358,155	)			(358,155	)
Accumulated other comprehensive income (loss)			(1,853	)			36,961
			652,734				560,917
		$	7,642,643			$	7,208,926

See accompanying notes to consolidated financial statements.

CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)

		Quarter Ended March 31
		2008				2007
		(as Restated, see NOTE 13)
Interest income:
Mortgage securities and similar investments		$	106,351			$	72,142
Other			804				62
			107,155				72,204
Interest expense:
Repurchase arrangements and similar borrowings			(69,306	)			(63,589	)
Unsecured borrowings			(2,187	)			(2,187	)
			(71,493	)			(65,776	)
			35,662				6,428
Other revenue (expense):
Loss from portfolio restructuring			(1,408	)			—
Other revenue (expense)			39				809
Other operating expense			(4,211	)			(1,674	)
			(5,580	)			(865	)
Income before equity in earnings of unconsolidated affiliates			30,082				5,563
Equity in earnings of unconsolidated affiliates			65				664
Net income		$	30,147			$	6,227
Net income available to common stockholders:
Net income		$	30,147			$	6,227
Less cash dividends paid on preferred shares			(5,064	)			(5,064	)
		$	25,083			$	1,163
Net income per common share:
Basic		$	0.54			$	0.06
Diluted		$	0.53			$	0.06
Cash dividends declared per share:
Common		$	0.520			$	0.020
Series A Preferred			0.400				0.400
Series B Preferred			0.315				0.315

See accompanying notes to consolidated financial statements.

CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)

		Quarter Ended March 31
		2008				2007
Operating activities:
Net income		$	30,147			$	6,227
Noncash items:
Amortization of investment premiums			7,127				5,671
Depreciation and other amortization			53				63
Equity-based compensation costs			320				214
Amounts related to interest rate swap agreements			186				—
Loss from portfolio restructuring			1,408				—
Net change in receivables, other assets, accounts payable and accrued expenses			(43,543	)			(5,172	)
Net cash (used in) provided by operating activities			(4,302	)			7,003
Investing activities:
Purchases of mortgage securities and similar investments			(1,461,893	)			(524,395	)
Proceeds from sales of mortgage securities and similar investments			766,800				—
Principal collections on mortgage securities and similar investments			384,104				423,150
Investment in unconsolidated affiliates			—				26
Net cash used in investing activities			(310,989	)			(101,219	)
Financing activities:
Proceeds from repurchase arrangements and similar borrowings			17,531,660				11,044,358
Principal payments on repurchase arrangements and similar borrowings			(17,235,730	)			(10,944,771	)
Early termination payment on interest rate swap agreement			(2,275	)			—
Capital stock transactions			131,189				19
Dividends paid			(14,851	)			(5,449	)
Net cash provided by financing activities			409,993				94,157
Net change in cash and cash equivalents			94,702				(59	)
Cash and cash equivalents at beginning of period			6,653				5,661
Cash and cash equivalents at end of period		$	101,355			$	5,602

See accompanying notes to consolidated financial statements.

CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
(unaudited)

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 real estate-related assets on a leveraged basis. These investments currently consist primarily of a core portfolio of residential adjustable-rate mortgage (“ARM”) securities issued and guaranteed by government-sponsored entities, either Fannie Mae or Freddie Mac, or by an agency of the federal government, Ginnie Mae (collectively, “Agency Securities”). Capstead may also invest a portion of its investment capital in credit-sensitive commercial real estate-related assets, including subordinate commercial real estate loans.

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 ended March 31, 2008 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2008. For further information refer to the consolidated financial statements and footnotes thereto incorporated by reference in the Company’s annual report on Form 10-K for the year ended December 31, 2007. Certain prior year amounts have been reclassified to conform to the current year presentation.

Accounting for Seller-financed Acquisitions of Mortgage Securities

Capstead generally pledges its Mortgage securities and similar investments as collateral under repurchase arrangements and a portion of the Company’s acquisitions may initially be financed with sellers. Consistent with prevailing industry practice, the Company records such assets and the related borrowings gross on its balance sheet, and the corresponding interest income and interest expense gross on its income statement. In addition, the asset is typically a security held available-for-sale, and any change in fair value of the asset is recorded as a component of Accumulated other comprehensive income (loss).

In February 2008 the FASB issued Staff Position 140-3 “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP140-3”). Under FSP140-3, certain seller-financed acquisitions entered into after December 31, 2008 may not qualify as sales from the sellers’ perspective and the sellers may be required to continue to consolidate the assets sold. As a result, investors such as Capstead may be precluded from presenting these seller-financed acquisitions gross on their balance sheets and required to report these assets net of the 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. FSP140-3 requires consideration as to whether this accounting should be followed in situations where

acquisitions and subsequent financing by a seller are sufficiently linked. Management does not believe implementing FSP140-3 will have a material effect on Capstead’s results of operations, taxable income or financial condition. Also, it is not expected to affect the Company’s status as a REIT or cause it to fail to qualify for its exemption under Investment Company Act of 1940 which requires that the Company must, among other things, maintain at least 55% of its assets directly in qualifying real estate interests.

Fair Value Accounting Rule Changes

In September 2006 the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS157”). SFAS157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS157’s valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs are internally derived, reflecting what the reporting entity believes to be market assumptions. SFAS157 classifies these inputs into the following hierarchy:

	•		Level One Inputs — Quoted prices for identical instruments in active markets.
	•		Level Two Inputs — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
	•		Level Three Inputs — Instruments with primarily unobservable value drivers.

In February 2007 the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (“SFAS159”). This statement permits, but does not require, entities to measure many financial instruments, including liabilities and certain other items, at fair value with resulting changes in fair value reported in earnings.

In adopting SFAS157 and SFAS159 on January 1, 2008, the Company determined that it was not necessary to make any substantive changes to its valuation practices and that presently it will not report changes in fair value of any of its financial assets or liabilities in earnings as allowed under SFAS159. Therefore, the adoption of these standards did not have any impact on the Company’s consolidated financial statements.

The Company’s holdings of 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. See NOTE 10 for a discussion of fair value methodology utilized and other related fair value disclosures. The Company’s interest rate swap agreements are also measured at fair value on a recurring basis primarily using Level Two Inputs that utilize 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 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. See NOTE 6 for related notional amount, terms and fair value disclosures related to these agreements.

NOTE 3 — EARNINGS PER COMMON SHARE

Basic earnings per common share is computed by dividing net income, after deducting preferred share dividends, by the weighted average number of common shares outstanding. Diluted earnings per common share is computed by dividing net income, after deducting dividends on convertible preferred shares when such shares are antidilutive, 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.

Components of the computation of basic and diluted earnings per common share were as follows (in thousands, except per share amounts):

		Quarter Ended March 31
		2008				2007
Numerators for basic earnings per common share:
Net income		$	30,147			$	6,227
Less Series A and B preferred share dividends			(5,064	)			(5,064	)
Income available to common stockholders		$	25,083			$	1,163
Weighted average common shares outstanding			46,154				18,933
Basic earnings per common share		$	0.54			$	0.06
Numerators for diluted earnings per common share:
Net income		$	30,147			$	6,227
Less dividends on antidilutive convertible preferred shares			—				(5,064	)
Income available to common stockholders		$	30,147			$	1,163
Denominator for diluted earnings per common share:
Weighted average common shares outstanding			46,154				18,933
Net effect of dilutive equity awards			441				121
Net effect of dilutive convertible preferred shares			9,818				—
			56,413				19,054
Diluted earnings per common share		$	0.53			$	0.06

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

		Quarter Ended March 31
		2008				2007
Shares issuable under option awards			—				205
Convertible preferred shares:
Series A shares			—				202
Series B shares			—				15,819

NOTE 4 — MORTGAGE SECURITIES AND SIMILAR INVESTMENTS

Mortgage securities and similar investments and related weighted average rates 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)
March 31, 2008
Agency Securities:
Fannie Mae/Freddie Mac:
Fixed-rate		$	12,162			$	34			$	12,196			$	12,219				6.64	%			6.41	%
ARMs			6,720,211				98,022				6,818,233				6,844,333				6.12				5.65
Ginnie Mae ARMs			468,412				2,328				470,740				474,972				5.70				5.45
			7,200,785				100,384				7,301,169				7,331,524				6.09				5.64
Residential mortgage loans:
Fixed-rate			6,882				(5	)			6,877				6,877				7.06				7.10
ARMs			10,628				95				10,723				10,723				6.83				7.00
			17,510				90				17,600				17,600				6.92				7.04
Commercial real estate loans			43,633				(295	)			43,338				43,338				8.51				10.82
Collateral for structured financings			5,048				83				5,131				5,131				8.15				7.96
		$	7,266,976			$	100,262			$	7,367,238			$	7,397,593				6.11				5.68
December 31, 2007
Agency Securities:
Fannie Mae/Freddie Mac:
Fixed-rate		$	13,079			$	36			$	13,115			$	13,138				6.63	%			6.43	%
ARMs			6,382,773				89,017				6,471,790				6,507,447				6.36				5.78
Ginnie Mae ARMs			515,091				2,465				517,556				521,288				5.87				5.62
			6,910,943				91,518				7,002,461				7,041,873				6.33				5.77
Residential mortgage loans:
Fixed-rate			7,412				(3	)			7,409				7,409				7.05				7.14
ARMs			11,097				96				11,193				11,193				7.18				7.05
			18,509				93				18,602				18,602				7.13				7.08
Commercial real estate loans			43,435				(439	)			42,996				42,996				10.46				12.21
Collateral for structured financings			5,162				86				5,248				5,248				8.14				8.07
		$	6,978,049			$	91,258			$	7,069,307			$	7,108,719				6.36				5.80

Agency Securities carry an implied AAA rating and therefore limited credit risk. Residential mortgage loans held by the Company were previously collateral underlying private residential mortgage pass-through securities formed before 1995 when Capstead operated a mortgage conduit. These loans are now carried as whole loans on the Company’s balance sheet with the related credit risk 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 pledged to secure these securitizations. The related credit risk is borne by bondholders of the securitization to which the collateral is pledged. The maturity of mortgage securities is directly affected by the rate of principal prepayments on the underlying mortgage loans.

Fixed-rate investments are either 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.

As of March 31, 2008, commercial real estate loans consist of several subordinated loans totaling $5.2 million accruing interest at 18% and scheduled to pay off in 2008 through townhome and land sales, and $38.2 million in subordinated loans accruing interest at a margin over one-month LIBOR on a luxury hotel property in the Caribbean, also scheduled to pay off in 2008.

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 well-established investment banking firms, the terms and conditions of which are negotiated on a transaction-by-transaction basis. Interest rates on these borrowings are generally based on a margin over the federal funds rate or a corresponding interest rate for longer-term borrowings and 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 investment 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 commercial real estate loan borrowing, of which $7 million was repaid May 1, 2008 and the remainder is payable on August 9, 2008, accrues interest at a margin over one-month LIBOR. 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 and 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):

		March 31, 2008								December 31, 2007
		Borrowings				Average				Borrowings				Average
Collateral Type		Outstanding				Rate*				Outstanding				Rate*
Borrowings with maturities of 30 days or less:
Agency Securities		$	4,268,212				2.92	%		$	4,963,674				4.93	%
Residential mortgage loans			10,926				4.10				14,352				6.12
			4,279,138				2.93				4,978,026				4.93
Borrowings with maturities greater than 30 days:
Agency Securities (31 to 90 days)			1,001,924				2.82				—				—
Agency Securities (91 to 360 days)			763,975				4.90				368,694				4.92
Agency Securities (greater than 360 days)			732,139				5.13				1,127,420				5.05
			2,498,038				4.13				1,496,114				5.02
Similar borrowings:
Commercial real estate loans			13,983				4.67				20,974				6.88
Collateral for structured financings			5,131				8.15				5,248				8.14
		$	6,796,290				3.38			$	6,500,362				4.96

Prior to changes in credit market conditions during the fall of 2007, Capstead 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 March 31, 2008, these longer-term committed borrowings consisted of a series of repurchase arrangements totaling $1.50 billion with remaining terms of from six to 17 months and an average maturity of 12 months. Capstead had $82 million of its capital at risk with its largest single counterparty (Cantor Fitzgerald & Company) related to $1.42 billion of these borrowings. 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. As of March 31, 2008 the Company’s swap position consisted of 13 swap agreements with an aggregate notional amount of $1.70 billion, an average remaining term of 21 months and an average fixed-rate of 3.47%. The interest rate swap agreements have been designated as cash flow hedges of the variability of the underlying benchmark interest rate of certain current and forecasted 30-day repurchase arrangements. This hedge relationship in effect establishes a relatively stable fixed borrowing rate on the designated borrowings with the variable-rate payments to be received on the swap agreements generally offsetting the interest owed on the designated borrowings that reset monthly to market rates, leaving the fixed-rate payments to be paid on the swap agreements as the Company’s effective borrowing rate, subject to certain adjustments.

As of March 31, 2008, a liability for $30.1 million was recorded on the balance sheet representing the fair value of the swap agreements at quarter-end. Included in Other revenue (expense) is a holding gain of $81,000 realized prior to designating one of these agreements as a cash flow hedge and included in Accumulated other comprehensive income (loss) are gross unrealized losses of $30.0 million incurred while the swap agreements were designated as cash flow hedges. In March 2008 a $100 million notional amount swap agreement was terminated for a realized loss of $2.3 million which is being amortized to earnings over the remaining 21 month term of the derivative (the related amortized balance in Accumulated other comprehensive income (loss) was $2.2 million as of March 31, 2008). During the first quarter of 2008 the effect of the Company’s hedging program utilizing swap agreements was a reduction in Interest expense of $374,000, consisting of net accrued cash inflows of $641,000 offset by measured hedge ineffectiveness of $267,000.

The weighted average effective interest rate on Repurchase arrangements and similar borrowings was 3.96% for first quarter 2008 including the effects of the swap agreements. The weighted average maturity of these borrowings was 3.5 months at March 31, 2008, with an average effective repricing period of 7.6 months including the effects of the interest rate swap agreements.

NOTE 7 — UNSECURED BORROWINGS

Unsecured borrowings consist of 30-year junior subordinated notes issued in September 2005, December 2005 and September 2006 by Capstead to Capstead Mortgage Trust I, Trust II and Trust III, respectively. 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 $2.8 million in remaining issue costs associated with these transactions. Note balances and related weighted average interest rates as of March 31, 2008 and December 31, 2007 (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 March 31, 2008.

NOTE 8 — RECENT COMMON EQUITY RAISES

In February 2008 Capstead completed its third public offering since September 2007 raising $126.7 million in new common equity capital, after underwriting discounts and offering expenses, through the issuance of 8.6 million common shares at a price of $15.50 per share. In March 2008 the Company raised an additional $4.6 million, after expenses, by issuing 360,100 common shares at an average price of $13.17 per share under its continuous offering program. In total, these issuances increased common equity capital by $131.3 million by quarter-end. Subsequent to quarter-end and through the filing date of this report, the Company further increased its common equity capital by $45.7 million, after expenses, through the issuance of 3,675,000 common shares at an average sales price of $12.72 per share under the continuous offering program. The Company may raise more capital in future periods subject to market conditions and blackout periods associated with the dissemination of earnings and dividend announcements and other important company-specific news. The accompanying March 31, 2008 financial statements and related disclosures do not reflect the effects of shares issued subsequent to quarter-end.

NOTE 9 — 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 derivative financial instruments held as cash flow hedges. As of March 31, 2008, the Accumulated other comprehensive income (loss) component of Stockholders’ equity consisted of $30.4 million in net unrealized gains on mortgage securities held available-for-sale, $30.0 million in net unrealized losses on interest rate swap agreements held as cash flow hedges and a net unamortized balance of $2.2 million associated with terminated cash flow hedges. The following provides information regarding the components of comprehensive income (loss) (in thousands):

		Quarter Ended March 31
		2008				2007
Net income		$	30,147			$	6,227
Other comprehensive income (loss):
Amounts related to cash flow hedges:
Change in net unrealized losses			(27,544	)			—
Early termination of interest rate swap agreement			(2,275	)			—
Reclassification adjustment for amounts included in net income			62				(12	)
Amounts related to available-for-sale securities:
Reclassification adjustments for amounts included in net income			1,408				—
Change in net unrealized gains			(10,465	)			9,466
Other comprehensive income (loss)			(38,814	)			9,454
Comprehensive income (loss)		$	(8,667	)		$	15,681

NOTE 10 — DISCLOSURES REGARDING FAIR VALUES OF FINANCIAL INSTRUMENTS

Fair values of most of Capstead’s financial assets and liabilities are influenced by changes in, and market expectations for changes in, interest rates and market liquidity conditions, as well as other factors beyond the control of management. Fair values of Mortgage securities and similar investments are estimated at each balance sheet date considering 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. Currently, only investments in mortgage securities classified as available-for-sale are reported at fair value on the Company’s balance sheet with unrealized gains and losses recorded as a component of Accumulated other comprehensive income (loss) in stockholder’s equity.

Fair value disclosures for mortgage securities classified as available-for-sale were as follows (in thousands):

						Gross				Gross
						Unrealized				Unrealized				Fair
		Basis				Gains				Losses				Value
As of March 31, 2008
Agency Securities		$	7,289,238			$	40,671			$	10,316			$	7,319,593
As of December 31, 2007
Agency Securities		$	6,989,619			$	42,023			$	2,611			$	7,029,031

Fair value disclosures for mortgage securities classified as held-to-maturity were as follows (in thousands):

						Gross				Gross
						Unrealized				Unrealized				Fair
		Basis				Gains				Losses				Value
As of March 31, 2008
Collateral released from structured financings (Agency Securities)		$	11,931			$	407			$	—			$	12,338
Collateral for structured financings			5,131				—				—				5,131
		$	17,062			$	407			$	—			$	17,469
As of December 31, 2007
Collateral released from structured financings (Agency Securities)		$	12,842			$	340			$	—			$	13,182
Collateral for structured financings			5,248				—				—				5,248
		$	18,090			$	340			$	—			$	18,430

Additional required disclosures for Mortgage securities and similar investments in an unrealized loss position were as follows (in thousands):

		March 31, 2008								December 31, 2007
		Fair				Unrealized				Fair				Unrealized
		Value				Loss				Value				Loss
Securities in an unrealized loss position:
One year or greater		$	246,222			$	2,768			$	323,751			$	1,856
Less than one year			2,189,306				7,548				382,482				755
		$	2,435,528			$	10,316			$	706,233			$	2,611
Commercial and residential loans in an unrealized loss position:
One year or greater		$	—			$	—			$	—			$	—
Less than one year			52,598				1,463				42,248				748
		$	52,598			$	1,463			$	42,248			$	748

Managing a large portfolio of primarily ARM Agency Securities remains the core focus of Capstead’s investment strategy and management expects these securities will be held to maturity absent a major shift in the Company’s investment focus. By focusing on investing in relatively short-duration and highly liquid ARM Agency Securities, declines in fair value caused by increases in interest rates are typically relatively modest compared to investments in longer-duration assets. These declines can be recovered 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 or prepay. Consequently, any such declines in value generally would not constitute other-than-temporary impairments in value necessitating impairment charges. From a credit risk and market liquidity perspective, the real or implied United States government guarantee associated with Agency Securities helps ensure that fluctuations in value due to perceived credit risk will be relatively modest and financing will remain available via repurchase arrangements.

In early March 2008 credit market conditions deteriorated, characterized by a significant contraction in market liquidity centering on concerns over pricing for mortgage securities, changes in terms of financing via short-term repurchase agreements and, most critically, the potential for adverse changes in the availability of financing to support leveraged portfolios of mortgage securities. In light of these conditions and concerns, Capstead began lowering its portfolio leverage through limited asset sales and other means. To this end, during March the Company sold Agency Securities with a cost basis of $768 million for a net realized loss of $1.4 million (gross realized losses of $2.7 million net of gross realized gains of $1.3 million) and temporarily curtailed replacing portfolio runoff. In addition, the Company has not

invested over $30 million of the capital raised in its February follow-on offering or any of the capital raised since March under its continuous offering program. Finally, the Company has expanded the number of lending counterparties with whom it routinely does business. Together, these actions have reduced portfolio leverage significantly and increased financial flexibility, thereby improving the Company’s ability to withstand periods of contracting market liquidity.

Commercial real estate loans held by Capstead also declined in value with the contraction in market liquidity that began in August 2007. These loans are well collateralized and are all scheduled to pay off during 2008.

NOTE 11 — LONG-TERM INCENTIVE AND OTHER PLANS

The Company sponsors long-term incentive plans to provide for the issuance of stock awards, option awards and other incentive-based equity awards to directors and employees (collectively, the “Plans”). As of March 31, 2008, the Plans had 1,757,957 common shares remaining available for future issuance.

The Company also 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. All Company contributions are subject to certain vesting requirements. Contribution expenses were $34,000 for the quarter ended March 31, 2008.

In May and June 2005 stock awards for a total of 172,600 common shares were issued to directors and employees (average grant date fair value: $7.86 per share) that vest in four annual installments, subject to certain restrictions, including continuous service. In December 2006 stock awards for a total of 197,500 common shares were issued to employees (grant date fair value: $8.19 per share) that vest in four annual installments beginning January 2, 2008, subject to similar restrictions. Also during 2006, stock awards for 21,457 common shares were issued to a new employee and certain directors (average grant date fair value: $6.86 per share), 6,457 shares of which were vested at grant with the remaining shares vesting proportionally over three years, subject to similar restrictions. In May 2007, stock awards totaling 6,000 common shares were issued to directors that vested April 15, 2008 (grant date fair value $9.81). In December 2007, stock awards totaling 150,000 common shares were issued to employees that vest in six annual installments beginning January 2, 2009 (grant date fair value $13.05) subject to similar restrictions. Stock award activity during the quarter ended March 31, 2008 is summarized below:

						Weighted Average
		Number of				Grant Date
		Shares				Fair Value
Stock awards outstanding as of December 31, 2007			431,200			$	9.82
Vested			(48,751	)			8.19
Stock awards outstanding as of March 31, 2008			382,449				10.03

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/director attrition. The risk-free rate is based on market rates for the expected life of the option. Expected dividends are based on historical experience and expectations for future performance. In measuring volatility factors in recent years, the Company considered volatilities experienced by certain other companies in the mortgage REIT industry in addition to historical volatilities of Capstead shares given past circumstances affecting the trading of Capstead shares not expected to reoccur.

During 2005 option awards granted to directors and employees totaled 430,000 shares with an average price of $7.85 and an average fair value of $0.61 per share, which was determined using average expected terms of four years, volatility factors of 27%, dividend yields of 10% and risk-free rates of 3.76%. During 2006 option awards granted to directors and employees totaled 258,000 shares with an average price of $7.43 and an average fair value of $0.78 per share, which was determined using average expected terms of four years, volatility factors of 31%, dividend yields of 10% and risk-free rates of 4.91%. During 2007 option awards granted to directors and employees totaled 220,500 shares with an average price of $10.46 and an average fair value of $0.89 per share, which was determined using average expected terms of four years, volatility factors of 27%, dividend yields of 10% and risk-free rates of 4.60%. Option award activity during the quarter ended March 31, 2008 is summarized below:

		Number of				Weighted Average
		Shares				Exercise Price
Option awards outstanding as of December 31, 2007			948,656			$	11.47
Expirations			(133,224	)			29.91
Exercises			(264,057	)			7.57
Option awards outstanding as of March 31, 2008			551,375			$	8.88

The weighted average remaining contractual term, average exercise price and aggregate intrinsic value for the 41,625 exercisable option awards outstanding as of March 31, 2008 was seven years, $9.36 and $115,000. The total intrinsic value of option awards exercised during the quarter ended March 31, 2008 was $2.7 million. Unrecognized compensation costs for all unvested equity awards totaled $3.5 million as of March 31, 2008, to be expensed over a weighted average period of three years.

NOTE 12 — NET INTEREST INCOME ANALYSIS

The following summarizes interest income, interest expense and weighted average interest rates as restated for the reclassification of other interest income and interest expense on unsecured borrowings — see NOTE 13 (dollars in thousands):

		Quarter Ended March 31
		2008								2007
						Average								Average
						Effective								Effective
		Amount				Rate				Amount				Rate
Interest income:
Mortgage securities and similar investments		$	106,351				5.68	%		$	72,142				5.50	%
Other			804				3.88				62				5.24
			107,155				5.66				72,204				5.50
Interest expense:
Repurchase arrangements and similar borrowings			(69,306	)			3.96				(63,589	)			5.19
Unsecured borrowings			(2,187	)			8.49				(2,187	)			8.49
			(71,493	)			4.03				(65,776	)			5.26
		$	35,662				1.63			$	6,428				0.24

Related changes in interest income and interest expense due to changes in interest rates versus changes in volume were as follows (in thousands):

		Rate*				Volume*				Total*
Interest income:
Mortgage securities and similar investments		$	2,434			$	31,775			$	34,209
Other			(20	)			762				742
			2,414				32,537				34,951
Interest expense:
Repurchase arrangements and similar borrowings			(17,339	)			23,056				5,717
Unsecured borrowings			—				—				—
			(17,339	)			23,056				5,717
		$	19,753			$	9,481			$	29,234

NOTE 13 — RESTATEMENT TO RECLASSIFY INTEREST INCOME,
INTEREST EXPENSE AND OTHER INCOME (EXPENSE)

After receiving a request from the Securities and Exchange Commission in a comment letter dated December 18, 2008, management concluded that the Company’s previously filed consolidated statements of operations for the three years ending December 31, 2007 and for the periods included in its Forms 10-Q filed in 2008, should be reclassified and restated to include interest expense from unsecured borrowings with interest expense from repurchase arrangements and similar borrowings in arriving at net interest margin rather than including interest expense from unsecured borrowings within Other revenue (expense). Accordingly, the consolidated statements of operations for these periods have been restated to reflect interest income from all sources under the caption “Interest income” and interest expense from all sources under the caption “Interest expense.” The resulting net interest margin subtotal no longer provides readers of the Company’s consolidated financial statements with solely the net interest margin earned on its portfolio of Mortgage securities and similar investments after directly-related secured borrowings, but a more all-inclusive measure of net interest margin that includes interest income earned on overnight cash investments and cash margin balances and interest costs associated with the unsecured borrowings.

The reclassifications contained in these restatements do not change the Company’s previously reported net income, earnings per share or stockholders’ equity for any of the periods presented. In addition, the restatements do not impact the Company’s consolidated balance sheets, statements of stockholders’ equity or cash flows for these periods.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Explanatory Note — See NOTE 13 to the consolidated financial statements for an
explanation of the reclassifying restatement of interest income, interest expense and other
revenue (expense) reflected throughout this filing.

FINANCIAL CONDITION

Overview

Capstead Mortgage Corporation (together with its subsidiaries, “Capstead” or the “Company”) operates as a self-managed real estate investment trust for federal income tax purposes (a “REIT”) and is based in Dallas, Texas. Capstead earns income from investing its long-term investment capital in real estate-related assets on a leveraged basis. Capstead’s core investment strategy is to conservatively manage a leveraged portfolio of residential adjustable-rate mortgage (“ARM”) securities issued and guaranteed by government-sponsored entities, either Fannie Mae or Freddie Mac, or by an agency of the federal government, Ginnie Mae (collectively, “Agency Securities”). Agency Securities carry an implied AAA rating with limited, if any, credit risk. Management believes this strategy can produce attractive risk-adjusted returns over the long term while virtually eliminating credit risk and reducing, but not eliminating, sensitivity to changes in interest rates.

Capstead increased its long-term investment capital during the first quarter of 2008 by raising $131 million in new common equity capital through an underwritten public offering that closed in February 2008 and its continuous offering program. Together with $180 million of perpetual preferred stockholders’ equity and $100 million of long-term unsecured borrowings (net of related investments in statutory trusts) Capstead ended the first quarter of 2008 with $753 million of long-term investment capital, up 14% from $661 million at the end of 2007. Subsequent to quarter-end, the Company further increased its long-term investment capital raising an additional $46 million in new common equity capital under its continuous offering program. The accompanying March 31, 2008 financial statements and related disclosures do not reflect the effects of shares issued subsequent to quarter-end.

Credit market conditions for investing in Agency Securities improved considerably in January and February 2008 from the relatively distressed levels experienced during the fall of 2007. However, in early March 2008 conditions again deteriorated, characterized by a significant contraction in market liquidity centering on concerns over pricing for mortgage securities, changes in terms of financing via short-term repurchase agreements and, most critically, the potential for adverse changes in the availability of financing to support leveraged portfolios of mortgage securities. In light of these conditions and concerns, Capstead began lowering its portfolio leverage through limited asset sales and other means. To this end, during March the Company sold Agency Securities with a cost basis of $768 million for a net realized loss of $1.4 million and temporarily curtailed replacing portfolio runoff. In addition, the Company has not invested over $30 million of the capital raised in its February follow-on offering or any of the capital raised since March under its continuous offering program. Finally, the Company has expanded the number of lending counterparties with whom it routinely does business. Together, these actions have reduced portfolio leverage significantly and increased financial flexibility, thereby improving the Company’s ability to withstand periods of contracting market liquidity.

As of March 31, 2008 Capstead’s mortgage securities and similar investments totaled $7.40 billion financed at a leverage ratio (secured borrowings divided by long-term investment capital) of nine-to-one compared to $7.11 billion at a leverage ratio of nearly ten-to-one at year-end. With the new common equity capital raised subsequent to quarter-end, the temporary curtailment of portfolio acquisitions, and improvements since quarter-end in the value of the Company’s swap position, Capstead’s portfolio leverage is currently approaching the low end of the Company’s traditional range of eight to 12 times long-term investment capital.

Financing spreads (the difference between yields on the Company’s investments and rates on related secured borrowings) averaged 172 basis points during the first quarter of 2008, up from 93 basis points earned during the fourth quarter of 2007. This increase of 79 basis points was primarily attributable to lower borrowing rates, which benefited from actions taken by the Federal Reserve Open Market Committee beginning in September 2007 to lower its target for the federal funds rate a total of 300 basis points to 2.25% by quarter-end.

The size and composition of Capstead’s investment portfolios depend on investment strategies being implemented by management, the availability of investment capital and overall market conditions, including the availability of attractively priced investments and suitable financing to appropriately leverage the Company’s investment capital. Market conditions are influenced by, among other things, current levels of, and expectations for future levels of, short-term interest rates, mortgage prepayments and market liquidity.

Risk Factors and Critical Accounting Policies

Under the captions “Risk Factors” and “Critical Accounting Policies” are discussions of risk factors and critical accounting policies affecting Capstead’s financial condition and results of operations that are an integral part of this discussion and analysis. Readers are strongly urged to consider the potential impact of these factors and accounting policies on the Company while reading this document.

Recent Common Equity Offerings

In February 2008 Capstead completed its third public offering since September 2007 raising nearly $127 million in new common equity capital, after underwriting discounts and offering expenses, through the issuance of 8.6 million common shares at a price of $15.50 per share. In March 2008 the Company raised an additional $4.6 million, after expenses, by issuing 360,100 common shares at an average price of $13.17 per share under its continuous offering program. In total, these issuances increased common equity capital by $131 million during the first quarter and were accretive to year-end book value by $0.97 per common share. Subsequent to quarter-end, the Company further increased its common equity capital by nearly $46 million, after expenses, through the issuance of 3.7 million common shares at an average sales price of $12.72 per share under the continuous offering program. The Company may raise more capital in future periods, subject to market conditions and blackout periods associated with the dissemination of earnings and dividend announcements and other important company-specific news. The accompanying March 31, 2008 financial statements and related disclosures do not reflect the effects of shares issued subsequent to quarter-end.

Book Value per Common Share

As of March 31, 2008, Capstead’s book value per common share (total stockholders’ equity less liquidation preferences of the Company’s Series A and B preferred shares divided by shares outstanding) was $9.40, an increase of $0.15 from December 31, 2007. Most of the accretion from common equity offerings that closed prior to quarter-end was offset by lower quarter-end values assigned to the Company’s interest rate swap positions due primarily to lower prevailing market interest rates as well as lower values assigned to the Company’s residential mortgage securities portfolio primarily as a result of the market turmoil experienced in March. Higher market interest rates subsequent to quarter-end have led to a significant improvement in value of the Company’s swap positions and the ongoing recovery in financial market conditions has resulted in improved pricing for ARM Agency Securities relative to these higher rates. Together with accretive issuances of new common equity capital in April and to date in May, these developments have had a positive effect on book value since quarter-end.

While nearly all of the Company’s investments and all of its interest rate swap positions are reflected at fair value on the Company’s balance sheet and therefore included in the calculation of book value per common share, unrealized gains or losses on longer-term committed borrowings supporting investments in longer-to-reset ARM securities are not reflected in book value. As of March 31, 2008, these longer-term borrowings consisted of a series of repurchase arrangements entered into prior to September 2007 with remaining terms of from six to 17 months and unrealized losses totaling $40 million. As these borrowings approach maturity, related unrealized losses will decline and ultimately be eliminated.

Company Response to Recent Credit Market Conditions

Credit market conditions for investing in Agency Securities improved considerably in January and February 2008 from the relatively distressed levels experienced during the fall of 2007. However, in early March 2008 conditions again deteriorated, characterized by a significant contraction in market liquidity centering on concerns over pricing for mortgage securities, changes in terms of financing via short-term repurchase agreements and, most critically, the potential for adverse changes in the availability of financing to support leveraged portfolios of mortgage securities. In light of these conditions and concerns, Capstead began lowering its portfolio leverage through limited asset sales and other means. To this end, during March the Company sold Agency Securities with a cost basis of $768 million for a net realized loss of $1.4 million and temporarily curtailed replacing portfolio runoff. In addition, the Company has not invested over $30 million of the capital raised in its February follow-on offering or any of the capital raised since March under its continuous offering program. Finally, the Company has expanded the number of lending counterparties with whom it routinely does business. Together, these actions have reduced portfolio leverage significantly and increased financial flexibility, thereby improving the Company’s ability to withstand periods of contracting market liquidity.

In late March and into April credit market conditions began improving largely due to actions taken by the Federal Reserve to support the mortgage securities market by providing additional financing to both banks and primary broker dealers and orchestrating the acquisition of The Bear Stearns Companies, Inc. by JPMorgan Chase & Co. Additionally, actions taken by federal regulators to allow Fannie Mae, Freddie Mac and the Federal Home Loan Banks to expand their holdings of Agency Securities have provided further support to the credit markets. These actions have improved pricing for most Agency Securities, increased the availability of financing via short-term repurchase agreements and have largely stalled momentum toward higher collateral requirements beyond commonly seen levels of 5%. Management is cautiously optimistic that these improvements in credit market conditions may be indicative of a sustained recovery and that the market turbulence experienced since last August has begun to abate.

With the actions taken by the Federal Reserve to reduce the federal funds target rate aggressively this year, the target rate now stands at 2.00%, down 225 basis points since year-end and 325 basis points from late last summer. As a result, the Company’s borrowing rates have declined considerably the last two quarters and can be expected to continue declining during the second quarter leading to further expansion of financing spreads even as portfolio yields decline with lower ARM loan coupon resets and somewhat higher mortgage prepayments. Net interest margins have also benefited from higher portfolio balances even as the Company has lowered its portfolio leverage from nearly ten to one at year-end to nine to one at quarter-end and is currently approaching the low end of the Company’s traditional leverage range of eight to 12 times long-term investment capital. Given these strong operating fundamentals, management anticipates that the Company will earn attractive returns on the portfolio in the coming quarters.

Residential Mortgage Investments

Managing a large portfolio of residential mortgage investments consisting primarily of ARM Agency Securities is the core focus of Capstead’s investment strategy. As of March 31, 2008, residential

mortgage investments totaled $7.35 billion, up from $7.07 billion at year-end, and consisted of over 99% ARM Agency Securities. Agency Securities carry an implied AAA-rating with limited credit risk. By focusing on investing in relatively short-duration and highly liquid ARM Agency Securities, declines in fair value caused by increases in interest rates are typically relatively modest compared to investments in longer-duration, fixed-rate assets. These declines can be recovered 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. Additionally, mortgage coupon resets tend to allow for the recovery of financing spreads diminished during periods of rising interest rates. From a credit risk and market liquidity perspective, the real or implied United States government guarantee associated with Agency Securities helps ensure that fluctuations in value due to perceived credit risk will be relatively modest and financing will remain available via repurchase arrangements.

Residential mortgage investments held by Capstead that are not agency-guaranteed were limited to less than $23 million as of March 31, 2008 and are the remnants of a mortgage loan conduit operation operated by the Company in the early 1990’s. The Company holds the related credit risk associated with $18 million of these loans, and the rest of these investments are held as collateral for structured financings whereby the related credit risk is borne by the securitizations’ bondholders. Delinquencies are of little consequence for these investments given the underlying collateral values associated with these extremely well seasoned mortgages. Given the modest size of this legacy portfolio, further discussion and analysis of the residential mortgage investment portfolio may ignore any distinction between these loans and securities and Agency Securities.

ARM securities are backed by residential mortgage loans that have coupon interest rates that adjust at least annually to a margin over a current short-term interest rate index or begin doing so after an initial fixed-rate period subject to periodic and lifetime limits, referred to as caps. See “NOTE 4” to the accompanying consolidated financial statements for additional information regarding interest rate resets on the Company’s investments. 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. As of quarter-end, Capstead’s residential mortgage securities were split 56% to 44% between current-reset and longer-to-reset ARM Agency Securities. As of March 31, 2008, the Company’s ARM securities featured the following average current and fully-indexed weighted average coupon rates, net of servicing and other fees (“WAC”), net margins, periodic and lifetime caps, and months-to-roll (dollars in thousands):

										Fully				Average					Average			Average				Months
						Net				Indexed				Net				Periodic				Lifetime				To
ARM Type		Basis*				WAC				WAC				Margins				Caps				Caps				Roll
Current-reset ARMs:
Agency Securities:
Fannie Mae/Freddie Mac		$	3,609,428				6.09	%			3.94	%			1.85	%			4.33	%			10.32	%			3.8
Ginnie Mae			470,740				5.70				3.03				1.53				1.00				9.94				5.5
Residential mortgage loans			10,723				6.83				4.60				2.06				1.54				11.17				4.9
			4,090,891				6.05				3.84				1.81				3.94				10.28				4.0
Longer-to-reset ARMs:
Agency Securities:
Fannie Mae/Freddie Mac			3,208,805				6.15				4.08				1.65				2.83				11.69				42.6
		$	7,299,696				6.09				3.95				1.74				3.45				10.90				20.9

Capstead typically finances its current-reset ARM securities using 30-day borrowings that reset monthly at a margin over the federal funds rate although when available at attractive terms, these terms may be extended to up to 90 days. Prior to the credit market turmoil that began last fall, the Company used longer-dated repurchase arrangements to effectively lock in financing spreads on investments in longer-to-reset ARM securities for a significant portion of the fixed-rate terms of these investments. As of March 31, 2008, these longer-term committed borrowings consisted of a series of repurchase arrangements totaling $1.50 billion with remaining terms of from six to 17 months and an average maturity of 12 months. Currently, the Company has borrowings with 18 active repurchase agreement counterparties, up from 14 at year-end and is pursuing further counterparty relationships. With the pending acquisition of Bear Stearns by JPMorgan Chase, the Company has reduced its borrowings with Bear Stearns to less than $100 million. Borrowings under repurchase arrangements supporting residential mortgage investments totaled $6.78 billion at March 31, 2008.

In late November 2007 the Company began using two-year term, one- and three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements to effectively lock in fixed rates on a portion of its 30-day borrowings because longer-term committed borrowings were no longer available at attractive terms. As of March 31, 2008 these swap agreements had notional amounts totaling $1.70 billion and were designated as cash flow hedges for accounting purposes of a like amount of the Company’s 30-day borrowings. The Company intends to continue to manage interest rate risk associated with holdings of longer-to-reset ARM securities by utilizing suitable derivative financial instruments (“Derivatives”) such as interest rate swap agreements and longer-dated committed borrowings if available at attractive terms.

Annualized portfolio runoff rates declined to 19% during the first quarter of 2008 compared to 24% during the fourth quarter of 2007 and 30% during the third quarter of 2007. This decline can be attributed to seasonal factors, larger holdings of longer-to-reset ARM securities and a generally less favorable mortgage lending environment, reflecting national trends toward declining home values and tighter mortgage loan underwriting standards. These factors are expected to continue to plague homeowners seeking to sell their homes or refinance their mortgages, which may allow the Company to experience more favorable runoff trends than would otherwise occur in a declining interest rate environment. Since Capstead typically purchases investments at a premium to the asset’s unpaid principal balance, high levels of mortgage prepayments can put downward pressure on ARM security yields because the level of mortgage prepayments impacts how quickly these investment premiums are written off against earnings as portfolio yield adjustments.

Commercial Real Estate-related Assets

Since the spring of 2000 when Capstead adopted its core strategy of managing a leveraged portfolio of primarily ARM Agency Securities, the Company has had the goal of augmenting this core portfolio with investments in credit-sensitive commercial real estate-related assets that can earn attractive risk-adjusted returns. Management believes such investments can provide an additional earnings stream to help support overall earnings during periods of rising short-term interest rates. Over the years these alternative investments have included a portfolio of net-leased senior living centers as well as commercial mortgage securities and subordinated loans supported by interests in commercial real estate. In all instances the overall level of capital committed to these investments has been relatively modest, primarily because the related risk-adjusted returns on additional investments have not been compelling.

While in the near term management is focusing its efforts on Capstead’s core portfolio of ARM Agency Securities, management is continuing to monitor developments in the commercial real estate markets that are currently experiencing widening credit spreads and significant liquidity constraints. As of March 31, 2008, Capstead’s investments in commercial real estate-related assets consisted of several subordinated loans totaling $5 million to a Dallas, Texas-based developer scheduled to be repaid during 2008 through townhome and land sales and $38 million in subordinated loans on a luxury hotel property in the Caribbean that is also scheduled to be repaid in 2008. The latter investment is financed using a committed master repurchase agreement. Of the $14 million borrowed under this facility at quarter-end, $7 million was repaid on May 1, 2008 and the remainder is payable on August 9, 2008.

Utilization of Long-term Investment Capital and Potential Liquidity

Capstead finances a majority of its holdings of residential mortgage securities with well-established investment banking firms using repurchase arrangements with the balance, or margin, supported by the Company’s long-term investment capital. Long-term investment capital includes preferred and common equity capital as well as unsecured borrowings, net of Capstead’s investment in related statutory trusts accounted for as unconsolidated affiliates. Assuming potential liquidity is available, borrowings can be increased or decreased on a daily basis to meet cash flow requirements and otherwise manage capital resources efficiently. Consequently, the actual level of cash and cash equivalents carried on Capstead’s balance sheet is significantly less important than the potential liquidity inherent in the Company’s investment portfolios. Potential liquidity is affected by, among other things, real (or perceived) changes in market value of assets pledged; principal prepayments; collateral requirements of the Company’s lenders; and general conditions in the investment banking, mortgage finance and real estate industries. Future levels of portfolio leverage will be dependent upon many factors, including the size and composition of the Company’s investment portfolios (see “Liquidity and Capital Resources”). Capstead’s utilization of long-term investment capital and its estimated potential liquidity were as follows as of March 31, 2008 in comparison with December 31, 2007 (in thousands):

						Related				Capital				Potential
		Investments(a)				Borrowings				Employed(a)				Liquidity(a)
Residential mortgage securities		$	7,354,255			$	6,782,307			$	571,948			$	311,087
Commercial real estate-related assets			43,338				13,983				29,355				(6,991	)
		$	7,397,593			$	6,796,290				601,303				304,096
Other assets, net of other liabilities											177,366				101,355
First quarter common dividend											(25,957	)			(25,957	)(b)
										$	752,712			$	379,494
Balances as of December 31, 2007		$	7,108,719			$	6,500,362			$	660,895			$	371,196

In order to prudently and efficiently manage its liquidity and capital resources, Capstead attempts to maintain sufficient liquidity reserves to fund margin calls (requirements to pledge additional collateral or pay down borrowings) required by monthly principal payments (that are not remitted to the Company for 20 to 45 days after any given month-end) and anticipated declines in the market value of pledged assets under stressed market conditions.

Accounting for Seller-Financed Acquisitions of Mortgage Securities

Capstead generally pledges its residential mortgage investments as collateral under repurchase arrangements and a portion of the Company’s acquisitions may initially be financed with sellers. In February 2008 the Financial Accounting Standards Board issued Staff Position 140-3 “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP140-3”). Under FSP140-3 certain seller-financed acquisitions entered into after December 31, 2008 may not qualify as sales from the sellers’ perspective and the sellers may be required to continue to consolidate the assets sold. As a result, buyers such as Capstead may be precluded from presenting these seller-financed acquisitions gross on their balance sheets and required to report the assets net of related liabilities 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. FSP140-3 requires consideration as to whether the accounting described above should be followed in situations where acquisitions and subsequent financing by a seller are sufficiently linked. Management does not believe implementing FSP140-3 will have a material effect on Capstead’s results of operations, taxable income or financial condition. Also, it is not expected to affect the Company’s status as a REIT or cause it to fail to qualify for its exemption under Investment Company Act of 1940 which requires that the Company must, among other things, maintain at least 55% of its assets directly in qualifying real estate interests.

RESULTS OF OPERATIONS

Comparative income statement data (in thousands, except for per share data) and key portfolio statistics (dollars in millions) were as follows:

		Quarter Ended March 31
		2008				2007
		(as Restated, see
		“Explanatory Note”)
Income statement data:
Mortgage securities and similar investments (interest income net of directly-related interest expense):
Residential mortgage investments		$	36,247			$	8,433
Commercial real estate investments			798				120
			37,045				8,553
Other interest income			804				62
Interest expense on unsecured borrowings			(2,187	)			(2,187	)
			35,662				6,428
Other revenue (expense):
Loss from portfolio restructuring			(1,408	)			—
Other revenue			39				809
Other operating expense			(4,211	)			(1,674	)
			(5,580	)			(865	)
Equity in earnings of unconsolidated affiliates			65				664
Net income		$	30,147			$	6,227
Net income available to common stockholders, after payment of preferred share dividends		$	25,083			$	1,163
Net income per common share:
Basic		$	0.54			$	0.06
Diluted		$	0.53			$	0.06
Weighted average common shares outstanding:
Basic			46,154				18,933
Diluted			56,413				19,054
Key portfolio statistics (excludes overnight balances and unsecured borrowings):
Average yields:
Residential mortgage investments			5.65	%			5.49	%
Commercial real estate investments			10.82				18.00
Total average yields			5.68				5.50
Average rate of related borrowings			3.96				5.19
Average financing spread			1.72				0.31
Average portfolio balances:
Residential mortgage investments		$	7,451			$	5,247
Commercial real estate investments			43				3
			7,494				5,250
Average related borrowings			6,923				4,901
Average capital deployed		$	571			$	349
Average portfolio runoff rate			19	%			28	%