Capstead Mortgage Corporation**Consolidated Statements of Income***(In thousands, except per share amounts)*               ***Year Ended December 31***   ***2007***  ***2006***  ***2005***   ***(as Restated, see NOTE 16)***              **Interest income:**            Mortgage securities and similar investments $310,698  $242,859  $130,333 Other  945   413   332              311,643   243,272   130,665           **Interest expense:**            Repurchase arrangements and similar borrowings  (266,901)  (228,379)  (105,937)Unsecured borrowings  (8,747)  (7,142)  (972)             (275,648)  (235,521)  (106,909)             35,995   7,751   23,756           **Other revenue (expense):**            Loss from portfolio restructuring  (7,683)  —   — Other revenue  1,289   178   750 Other operating expense  (6,671)  (6,454)  (7,301)             (13,065)  (6,276)  (6,551)          **Income before equity in earnings (loss) of unconsolidatedaffiliates and discontinued operation**  22,930   1,475   17,205 **Equity in earnings (loss) of unconsolidated affiliates**  1,783   2,368   (10)          **Income from continuing operations**  24,713   3,843   17,195 **Income from discontinued operation, net of taxes**  —   —   39,997           **Net income** $24,713  $3,843  $57,192           **Net income available (loss attributable) to commonstockholders:**            Net income $24,713  $3,843  $57,192 Less cash dividends paid on preferred shares  (20,256)  (20,256)  (20,256)            $4,457  $(16,413) $36,936           **Basic and diluted earnings (loss) per common share:**            Income (loss) from continuing operations $0.19  $(0.87) $(0.16)Income from discontinued operation  —   —   2.12             $0.19  $(0.87) $1.96           *See accompanying notes to consolidated financial statements.*
2

 
Capstead Mortgage Corporation**Consolidated Balance Sheets***(In thousands, except per share amounts)*           ***December 31***   ***2007***  ***2006***           **Assets:**        Mortgage securities and similar investments($6.7 billion pledged under repurchase arrangements) $7,108,719  $5,252,399 Investments in unconsolidated affiliates  3,117   20,073 Receivables and other assets  90,437   69,869 Cash and cash equivalents  6,653   5,661          $7,208,926  $5,348,002        **Liabilities:**        Repurchase arrangements and similar borrowings $6,500,362  $4,876,134 Unsecured borrowings  103,095   103,095 Interest rate swap agreements at fair value  2,384   — Common stock dividend payable  9,786   385 Accounts payable and accrued expenses  32,382   28,426           6,648,009   5,008,040        **Stockholders’ equity:**        Preferred stock — $0.10 par value; 100,000 shares authorized:        $1.60 Cumulative Preferred Stock, Series A,202 shares issued and outstanding atDecember 31, 2007 and December 31, 2006($3,317 aggregate liquidation preference)  2,828   2,828 $1.26 Cumulative Convertible Preferred Stock, Series B,15,819 shares issued and outstanding atDecember 31, 2007 and December 31, 2006($180,025 aggregate liquidation preference)  176,705   176,705 Common stock — $0.01 par value; 100,000 shares authorized;40,819 and 19,253 shares issued and outstanding atDecember 31, 2007 and December 31, 2006, respectively  408   192 Paid-in capital  702,170   497,418 Accumulated deficit  (358,155)  (354,617)Accumulated other comprehensive income  36,961   17,436           560,917   339,962          $7,208,926  $5,348,002        *See accompanying notes to consolidated financial statements.*
3

 
Capstead Mortgage Corporation**Consolidated Statements of Stockholders’ equity***(In thousands, except per share amounts)*                                           ***Accumulated***                      ***Other***  ***Total***   ***Preferred***  ***Common***  ***Paid-in***  ***Accumulated***  ***Comprehensive***  ***Stockholders’***   ***Stock***  ***Stock***  ***Capital***  ***Deficit***  ***Income***  ***Equity***                           **Balance at January 1, 2005** $179,533  $188  $516,704  $(387,718) $23,832  $332,539                         Net income  —   —   —   57,192   —   57,192 Other comprehensive income:                        Amounts related to cash flowhedges, net  —   —   —   —   403   403 Change in unrealized gain onmortgage securities, net  —   —   —   —   (19,239)  (19,239)                        Comprehensive income                      38,356 Cash dividends:                        Common — $0.32 per share  —   —   (2,217)  (3,846)  —   (6,063)Preferred  —   —   (1,825)  (18,431)  —   (20,256)Additions to capital  —   2   271   —   —   273                    **Balance at December 31, 2005**  179,533   190   512,933   (352,803)  4,996   344,849                         Net income  —   —   —   3,843   —   3,843 Other comprehensive income:                        Amounts related to cash flowhedges, net  —   —   —   —   (55)  (55)Change in unrealized gain onmortgage securities, net  —   —   —   —   12,495   12,495                         Comprehensive income                      16,283 Cash dividends:                        Common — $0.08 per share  —   —   (1,527)  —   —   (1,527)Preferred  —   —   (14,599)  (5,657)  —   (20,256)Additions to capital  —   2   611   —   —   613                    **Balance at December 31, 2006**  179,533   192   497,418   (354,617)  17,436   339,962                         Net income  —   —   —   24,713   —   24,713 Other comprehensive income:                        Amounts related to cash flowhedges, net  —   —   —   —   (2,608)  (2,608)Change in unrealized gain onmortgage securities, net  —   —   —   —   22,133   22,133                         Comprehensive income                      44,238 Cash dividends:                        Common — $0.34 per share  —   —   (1,152)  (10,571)  —   (11,723)Preferred  —   —   (2,576)  (17,680)  —   (20,256)Additions to capital  —   216   208,480   —   —   208,696                    **Balance at December 31, 2007** $179,533  $408  $702,170  $(358,155) $36,961  $560,917                    *See accompanying notes to consolidated financial statements.*
4

 
Capstead Mortgage Corporation**Consolidated Statements of Cash Flows***(In thousands)*               ***Year Ended December 31***   ***2007***  ***2006***  ***2005***               **Operating activities:**            Net income $24,713  $3,843  $57,192 Noncash items:            Amortization of investment premiums  24,091   23,108   21,813 Depreciation and other amortization  225   183   119 Equity-based compensation costs  921   529   249 Undistributed earnings of unconsolidated affiliates  —   (116)  18 Amounts related to interest rate swap agreements  (121)  —   — Loss on portfolio restructuring  7,683   —   — Gain on redemption of structured financing  —   —   (156)Gain on sale of discontinued operation (real estate held for lease)  —   —   (38,196)Net change in receivables, other assets, accounts payable andaccrued expenses  (663)  6,442   (3,749)          Net cash provided by operating activities of continuing operations  56,849   33,989   37,290 Net cash provided by operating activities of discontinued operation  —   —   3,104           Net cash provided by operating activities  56,849   33,989   40,394           **Investing activities:**            Purchases of mortgage securities and similar investments  (4,447,054)  (2,628,826)  (2,474,812)Proceeds from sales of mortgage securities and similar investments  845,151   —   — Principal collections on mortgage securities and similar investments  1,751,046   1,724,316   1,494,220 Investments in unconsolidated affiliates:            Investment in statutory trusts formed to issue unsecured borrowings  —   (774)  (2,321)Investment in commercial real estate loan limited partnership  (5,892)  (12,749)  (6,943)Return of investment in real estate loan limited partnership  9,519   2,812   —           Net cash used in investing activities of continuing operations  (1,847,230)  (915,221)  (989,856)Net cash (used in) provided by investing activities of discontinuedoperation including net proceeds from its sale  —   (2,884)  56,759           Net cash used in investing activities  (1,847,230)  (918,105)  (933,097)          **Financing activities:**            Proceeds from repurchase arrangements and similar borrowings  46,208,141   40,818,254   31,196,605 Principal payments on repurchase arrangements and similar borrowings  (44,599,642)  (39,965,780)  (30,393,738)Early termination payment on repurchase arrangements  (2,335)  —   — Unsecured borrowings, net of issue costs  —   25,061   75,038 Release of restricted cash  —   —   5,996 Capital stock transactions  207,787   84   24 Dividends paid  (22,578)  (21,779)  (30,089)          Net cash provided by financing activities of continuing operations  1,791,373   855,840   853,836 Net cash used in financing activities of discontinued operation  —   —   (226)          Net cash provided by financing activities  1,791,373   855,840   853,610           **Net change in cash and cash equivalents**  992   (28,276)  (39,093)Cash and cash equivalents at beginning of year  5,661   33,937   73,030           **Cash and cash equivalents at end of year** $6,653  $5,661  $33,937           *See accompanying notes to consolidated financial statements.*
5

 
Capstead Mortgage Corporation**Notes to Consolidated Financial Statements***December 31, 2007***NOTE 1 — BUSINESS**     Capstead Mortgage Corporation operates as a self-managed real estate investment trust forfederal income tax purposes (a “REIT”) and is based in Dallas, Texas. Unless the context otherwiseindicates, 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 ona leveraged basis. These investments currently consist primarily of a core portfolio ofresidential adjustable-rate mortgage (“ARM”) securities issued and guaranteed bygovernment-sponsored entities, either Fannie Mae or Freddie Mac, or by an agency of the federalgovernment, Ginnie Mae (collectively, “Agency Securities”). Capstead may also invest a portion ofits investment capital in credit-sensitive commercial real estate-related assets, includingsubordinate commercial real estate loans.**NOTE 2 — ACCOUNTING POLICIES*****Basis of Presentation***     The consolidated financial statements include the accounts of Capstead Mortgage Corporationand its wholly-owned and majority-owned subsidiaries over which it exercises control. Capsteadalso considers the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No.46 “Consolidation of Variable Interest Entities,” (“FIN46”) in determining whether consolidation isappropriate for any variable interest entities in which the Company holds an interest. TheCompany’s commercial real estate loans are secured by interests in mortgages on, or entities thatown, commercial real estate and are subordinate to prior liens on these assets. Although theseloans are considered variable interests in the entities that own the underlying real estate,Capstead is not considered the primary beneficiary and therefore these entities are notconsolidated. The common securities held by Capstead statutory trusts organized by the Companyunder Delaware law to issue long-term unsecured borrowings are not considered variable interests atrisk pursuant to the provisions of FIN46. Capstead accounts for these investments under the equitymethod of accounting. Investments in unconsolidated affiliates are initially recorded at cost andsubsequently adjusted for Capstead’s equity in earnings and losses and cash contributions anddistributions. All significant intercompany balances and transactions have been eliminated.     Certain prior year amounts have been reclassified to conform to the current year presentation.Also see NOTE 16 — Restatement.***Accounting for Seller-financed Acquisitions of Mortgage Securities***     Capstead generally pledges its *Mortgage securities and similar investments*as collateral underrepurchase arrangements and a portion of the Company’s acquisitions may initially be financed withsellers. Consistent with prevailing industry practice, the Company records such assets and therelated borrowings gross on its balance sheet, and the corresponding interest income and interestexpense gross on its income statement. In addition, the asset is typically a security heldavailable-for-sale, and any change in fair value of the asset isrecorded as a component of *Accumulated other comprehensive income.*
6

 
Capstead Mortgage Corporation     In February 2008 the FASB issued Staff Position 140-3 “Accounting for Transfers of FinancialAssets and Repurchase Financing Transactions” (“FSP140-3”). Under FSP140-3, certainseller-financed acquisitions entered into after December 31, 2008 may not qualify as sales from thesellers’ 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-financedacquisitions gross on their balance sheets and required to report these assets net of the relatedfinancings at fair value with related changes in fair value reported in earnings until such time asthe assets are no longer financed with the sellers. FSP140-3 requires consideration as to whetherthis accounting should be followed in situations where acquisitions and subsequent financing by aseller are sufficiently linked. Management does not believe implementing FSP140-3 will have amaterial 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 itsexemption under Investment Company Act of 1940 which requires that the Company must, among otherthings, 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, *“FairValue Measurements”*(“SFAS157”). SFAS157 defines fair value, establishes a framework for measuringfair value, and expands disclosures about fair value measurements. In February 2007 the FASBissued 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 doesnot require, entities to measure many financial instruments, including liabilities and certainother items, at fair value with resulting changes in fair value reported in earnings. In adoptingSFAS157 and SFAS159 on January 1, 2008 the Company determined that it will not report changes infair value of any of its financial assets or liabilities in earnings. Therefore, the Company doesnot anticipate any impact on its consolidated financial statements from the adoption of thesestandards.***Accounting for Uncertainty in Income Taxes***     The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertaintyin Income Taxes,” (“FIN48”) on January 1, 2007. The Company did not recognize any liabilities forunrecognized tax benefits in implementing FIN48 at adoption or during 2007. Accordingly, FIN48 hashad no impact on the Company’s financial condition or results of operations. If applicable infuture periods, the Company will record interest and penalties accrued related to unrecognized taxbenefits in *Other revenue (expense).*No such accruals were necessary as of December 31, 2007.***Equity-based Compensation***     On January 1, 2006, Capstead adopted the provisions of SFAS No. 123(R) “Share-Based Payment”(“SFAS123R”). SFAS123R establishes accounting for equity-based awards to directors and employees.Under the provisions of SFAS123R, equity-based compensation cost is measured at grant date, basedon the fair value of the award, and is recognized as an expense over the related requisite serviceperiod. Through December 31, 2005 Capstead accounted for equity-based awards under the recognitionand measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees,” and related Interpretations (“APB25”) and provided the required pro formadisclosures ofSFAS No. 123 “Accounting for Stock-based Compensation” (“SFAS123”).
7

 
Capstead Mortgage Corporation     The Company used the modified prospective method of adopting SFAS123R. Accordingly, theCompany recognized in *Other operating expense*compensation expense totaling $171,000 and $153,000during 2007 and 2006, respectively, relating to option awards granted since January 1, 2006 and theunvested portion of option awards granted in prior years that were previously not given accountingrecognition in earnings. Additionally, $750,000 and $376,000 was expensed during 2007 and 2006,respectively, related to stock awards. The Company recognizes compensation cost for option awardson a straightline basis over the requisite service period for each portion of the award that vestsseparately. Compensation cost for stock awards is recognized on a straightline basis over therequisite service period for the entire award. Equity-based compensation expense recognized forthe year ended December 31, 2005 under APB25 totaled $249,000 and would have been $89,000 higherunder the fair value provisions of SFAS123, which would have reduced reported earnings (loss) pershare by one cent.***Use of Estimates***     The use of estimates is inherent in the preparation of financial statements in conformity withaccounting principles generally accepted in the United States. The amortization of investmentpremiums on financial assets is based on estimates of future prepayments on underlying mortgageloans, which are impacted by future changes in interest rates and other factors beyond the controlof management. Actual results could differ from those estimates, which could adversely affectearnings. Estimated fair values of financial assets held in the form of securities have beendetermined using available market information and appropriate valuation methodologies; however,considerable judgment is required in interpreting market data to develop these estimates. Inaddition, fair values fluctuate on a daily basis and are influenced by changes in, and marketexpectations for changes in, interest rates, market liquidity conditions, and levels of mortgageprepayments as well as other factors beyond the control of management. Accordingly, estimates offair value are as of the balance sheet dates and are not necessarily indicative of the amounts thatcould be realized in a current market exchange. The use of different market assumptions and/orestimation methodologies may have a material effect on estimated fair values, which would affectthe *Accumulated other comprehensive income*component of *Stockholders’ equity.****Cash and Cash Equivalents***     *Cash and cash equivalents*include unrestricted cash on hand and highly liquid investments withoriginal maturities of three months or less when purchased.***Financial Assets***     Most of Capstead’s financial assets are mortgage securities classified as available-for-saleand carried at fair value with unrealized gains and losses reported as a separate component of*Accumulated other comprehensive income*. A small portion of the Company’s mortgage investments thatwere originally acquired as collateral for structured financings are either classified asheld-to-maturity or held as whole loans and are carried at amortized cost (unpaid principalbalance, adjusted for unamortized investment premiums and discounts). Financial assets held in theform of whole loans are generally held for investment and recorded at amortized cost on anindividual basis. Any whole loans held for sale are carried at the lower of amortized cost or fairvalue on an aggregate basis. Any transfers from loans held for sale to loans held for investmentare recorded at the lower of amortized cost or fairvalue on the date of transfer. Financial assets are reviewed for potential impairment at each
8

 
Capstead Mortgage Corporationbalance sheet date. Other-than-temporary impairments of investments in mortgage securities canoccur with adverse changes in the financial condition of the issuer and changes in the Company’sintent and ability to hold the security until any declines in fair value are recovered. The amountof any such other-than-temporary impairment is measured by comparing the recorded amount of thesecurity to its fair value. An investment in a whole loan is considered impaired if it becomesprobable that the Company will be unable to collect all amounts due according to the loan’scontractual terms and the amount of any impairment is measured by comparing the recorded amount ofthe loan to the present value of expected cash flows or the fair value of related collateral. Anyimpairment charges would be recorded in *Other revenue (expense).*No impairment charges onfinancial assets have been recorded during the three years ended December 31, 2007. Interest isrecorded as income when earned. Investment premiums and discounts are recognized as adjustments to*Interest income*by the interest method over the expected life of the related financial assets.Realized gains and losses from sales are included in *Other revenue (expense)*. The cost offinancial assets sold is based on the specific identification method.***Borrowings***     Borrowings are carried at their unpaid principal balances, net of unamortized discounts andpremiums, when present. Discounts and premiums, as well as debt issue costs, which are recorded in*Receivables and other assets*, are recognized as adjustments to *Interest expense*by the interestmethod over the term of the related borrowings.***Dividend Classification***     Capstead records common and preferred share dividends in the *Accumulated deficit*component of*Stockholders’ equity*only to the extent of available earnings for the related quarterly or monthlyperiod. Any dividends declared in excess of available earnings are deemed returns of capital andare recorded as reductions of *Paid-in capital*. The classification of dividends for tax andfinancial reporting purposes will typically differ as a result of differences between taxableincome and *Net income,*differences with how income is allocated to dividends paid, and timingconsiderations in the distribution of taxable income.***Derivative Financial Instruments (“Derivatives”)***     Derivatives used by Capstead from time to time for risk management purposes are recorded asassets or liabilities and carried at fair value. The accounting for changes in fair value of eachDerivative held depends on whether it has been designated as a hedge for accounting purposes, aswell as the type of hedging relationship identified. Capstead will typically designate anyDerivatives held as cash flow hedges. To qualify as a cash flow hedge, at the inception of thehedge relationship the Company must anticipate and document that the hedge relationship will behighly effective and monitor ongoing effectiveness on at least a quarterly basis. As long as thehedge relationship remains effective, the effective portion of changes in fair value of theDerivative are recorded in *Accumulated other comprehensive income*and the ineffective portion isrecorded in earnings. Changes in fair value of Derivatives not held as accounting hedges, or forwhich the hedge relationship is deemed to no longer be highly effective, are recorded in earningsas a component of *Other revenue (expense)*.     Holding Derivatives creates exposure to credit risk related to the potential for failure onthe part of counterparties to honor their commitments. In addition, the Company may berequired to post collateral based on the market value of the Derivatives. In the event of
9

 
Capstead Mortgage Corporationdefault by a counterparty, the Company may have difficulty recovering its collateral and may notreceive payments provided for under the terms of the Derivative. To mitigate this risk, TheCompany uses only well-established investment banking firms as counterparties.     For most of the three years ended December 31, 2007, Capstead made limited use of Derivatives.Late in 2007 the Company began using interest rate swap agreements in cash flow hedgerelationships in order to hedge variability in borrowing rates due to changes in the underlyingbenchmark interest rate related to a designated portion of its current and anticipated future30-day borrowings. Variable-rate swap payments to be received and any measured hedgeineffectiveness are recorded in *Interest expense*as an offset to interest owed on the hedgedborrowings that reset to market rates generally on a monthly basis. Fixed-rate swap payments to bemade are also recorded in *Interest expense*resulting in an effectively fixed borrowing rate onthese borrowings, subject to certain adjustments.***Income Taxes***     Capstead Mortgage Corporation and its qualified REIT subsidiaries (“Capstead REIT”) haveelected to be taxed as a REIT. As a result, Capstead REIT is not taxed on taxable incomedistributed to stockholders if certain REIT qualification tests are met. Capstead’s policy is todistribute 100% of the taxable income of the REIT, after application of available tax attributes,within the time limits prescribed by the Internal Revenue Code, which may extend into thesubsequent taxable year. Capstead may find it advantageous from time to time to elect taxable REITsubsidiary status for certain of its subsidiaries. Taxable income of any taxable REIT subsidiariesis subject to federal and, where applicable, state income taxes. Income taxes are accounted forusing the liability method. Deferred income tax assets and liabilities are determined based ondifferences between the financial reporting and tax bases of assets and liabilities and aremeasured using enacted tax rates and laws that will be in effect when the differences are expectedto reverse.***Incentive Compensation***     The compensation committee of Capstead’s board of directors administers all incentivecompensation programs. At the beginning of each year, the committee adopts an incentive formula toprovide for the creation of an incentive pool for the payment of incentive compensation toemployees. While the adoption of the incentive formula provides a mechanism for determiningamounts to be included in the incentive pool, the committee has the discretion to administerincentive programs in a manner it deems appropriate in order to recognize and reward performance.The incentive formula followed during the two years ended December 31, 2006 was based on a 10%participation in the “modified total return” of Capstead in excess of a 10% benchmark return,multiplied by the Company’s beginning “modified common book value.” Modified total return wasmeasured as the change in modified common book value per share during the year, excluding theeffects of raising equity capital, together with common dividends per share. Modified common bookvalue was determined by excluding from total *Stockholders’ equity*the recorded value of preferredequity and adjusting for unrealized gains and losses on investments not included in *Accumulatedother comprehensive income*and for incentive pool accruals.     In December 2006 at the recommendation of the compensation committee, the board adopted a newincentive formula for years beginning January 1, 2007, which provides for the creation of anincentive pool equal to a 10% participation in the “earnings” of Capstead in excess of “benchmarkearnings.” For formula purposes, earnings equal net income available to common stockholdersexcluding incentive fee accruals and any gains or losses from
10

 
Capstead Mortgage Corporationportfolio restructurings. Benchmark earnings is determined by multiplying the average 10-year U.S.Treasury Rate plus 200 basis points by average common stockholders’ equity calculated excluding therecorded value of preferred equity, *Accumulated other comprehensive income*, incentive fee accrualsand any gains or losses from portfolio restructurings. For 2007 and 2006 no incentive compensationwas awarded. For 2005 incentive compensation totaling $1,261,000 was awarded in excess of amountsprescribed by the incentive formula in recognition of accomplishments during that year.**NOTE 3 — EARNINGS (LOSS) PER COMMON SHARE**     Basic earnings (loss) per common share is computed by dividing net income (loss), afterdeducting preferred share dividends, by the weighted average number of common shares outstanding.Diluted earnings (loss) per common share is computed by dividing net income (loss), after deductingdividends on convertible preferred shares when such shares are antidilutive, by the weightedaverage number of common shares and common share equivalents outstanding, giving effect to equityawards and convertible preferred shares, when such awards and shares are dilutive. For calculationpurposes the Series A and B preferred shares are considered dilutive whenever basic earnings percommon share exceeds each Series’ dividend divided by the conversion rate applicable for thatperiod. Components of the computation of basic and diluted earnings (loss) per common share wereas follows (in thousands, except per share amounts):               ***Year Ended December 31***   ***2007***  ***2006***  ***2005***  Numerators for basic earnings (loss) per common share:            Income from continuing operations $24,713  $3,843  $17,195 Less Series A and B preferred share dividends  (20,256)  (20,256)  (20,256)          Income from continuing operations available (loss attributable)to common stockholders  4,457   (16,413)  (3,061)Income from discontinued operation  —   —   39,997             $4,457  $(16,413) $36,936           Weighted average common shares outstanding  22,947   18,902   18,868           Basic earnings (loss) per common share:            Income (loss) from continuing operations $0.19  $(0.87) $(0.16)Income from discontinued operation  —   —   2.12             $0.19  $(0.87) $1.96           Numerators for diluted earnings (loss) per common share:            Income from continuing operations $24,713  $3,843  $17,195 Less dividends on antidilutive convertible preferred shares  (20,256)  (20,256)  (20,256)          Income from continuing operations available (loss attributable)to common stockholders  4,457   (16,413)  (3,061)Income from discontinued operation  —   —   39,997             $4,457  $(16,413) $36,936           Denominator for diluted earnings (loss) per common share:            Weighted average common shares outstanding  22,947   18,902   18,868 Net effect of dilutive equity awards  247   —   — Net effect of dilutive convertible preferred shares  —   —   —              23,194   18,902   18,868           Diluted earnings (loss) per common share:            Income (loss) from continuing operations $0.19  $(0.87) $(0.16)Income from discontinued operation  —   —   2.12             $0.19  $(0.87) $1.96           
11

 
Capstead Mortgage Corporation     Potentially dilutive securities excluded from the calculation of diluted earnings (loss) percommon share were as follows (in thousands):               ***Year Ended December 31***  ***2007*** ***2006*** ***2005***Equity awards:            Shares issuable under option awards  363   856   778 Nonvested stock awards  —   322   173 Convertible preferred shares:            Series A shares  202   202   202 Series B shares  15,819   15,819   15,819 **NOTE 4 — MORTGAGE SECURITIES AND SIMILAR INVESTMENTS**     *Mortgage securities and similar investments*and related weighted average rates classified bycollateral 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)*  ***December 31, 2007***                        Agency Securities:                        Fannie Mae/Freddie Mac:                        Fixed-rate $13,079  $36  $13,115  $13,138   6.63%  6.39%ARMs  6,382,773   89,017   6,471,790   6,507,447   6.36   5.63 Ginnie Mae ARMs  515,091   2,465   517,556   521,288   5.87   5.50                         6,910,943   91,518   7,002,461   7,041,873   6.33   5.61                      Residential mortgage loans:                        Fixed-rate  7,412   (3)  7,409   7,409   7.05   6.98 ARMs  11,097   96   11,193   11,193   7.18   6.82                         18,509   93   18,602   18,602   7.13   6.88 Commercial real estate loans  43,435   (439)  42,996   42,996   10.46   13.88 Collateral for structuredfinancings  5,162   86   5,248   5,248   8.14   7.97                        $6,978,049  $91,258  $7,069,307  $7,108,719   6.36   5.64                      ***December 31, 2006***                        Agency Securities:                        Fannie Mae/Freddie Mac:                        Fixed-rate $16,819  $52  $16,871  $16,895   6.63   6.30 ARMs  4,343,740   61,381   4,405,121   4,418,446   6.14   4.94 Ginnie Mae ARMs  752,301   2,757   755,058   758,660   5.23   4.78                         5,112,860   64,190   5,177,050   5,194,001   6.01   4.92                      Non-agency Securities:                        Fixed-rate  17,734   41   17,775   17,804   7.19   6.57 ARMs  31,562   303   31,865   32,164   6.99   6.00                         49,296   344   49,640   49,968   7.06   6.21 Commercial real estate loans  2,635   —   2,635   2,635   18.00   18.00 Collateral for structuredfinancings  5,705   90   5,795   5,795   8.06   7.36                        $5,170,496  $64,624  $5,235,120  $5,252,399   6.03   4.94                       *(a)* *Includes mark-to-market for securities classified as available-for-sale, if applicable (seeNOTE 9).* *(b)* *Net WAC, or weighted average coupon, is presented net of servicing and other fees as of theindicated balance sheet date. Average Yield is presented for the year then ended, calculatedincluding the amortization of investment premiums and mortgage insurance costs on Non-agencySecurities and excluding unrealized gains and losses.*
12

 
Capstead Mortgage Corporation     Agency Securities carry an implied AAA rating and therefore limited, if any, credit risk.Private residential mortgage pass-through securities formed prior to 1995 when Capstead operated amortgage conduit are referred to as “Non-agency Securities.” Residential mortgage loans wereformerly held as Non-agency Securities that are now carried as whole loans on the Company’s balancesheet with the related credit risk borne by the Company. Commercial real estate loans aresubordinate loans that carry credit risk associated with specific commercial real estatecollateral. Collateral for structured financings consists of Non-agency Securities pledged tosecure these securitizations. The related credit risk is borne by bondholders of thesecuritization to which the collateral is pledged. The maturity of mortgage securities is directlyaffected by the rate of principal prepayments on the underlying mortgage loans.     Fixed-rate investments are either Agency Securities, Non-Agency Securities or residentialmortgage loans formerly held as Non-Agency Securities backed by mortgage loans that have fixedrates of interest over the contractual term of the loans. Adjustable-rate investments generallyare ARM Agency Securities backed by residential mortgage loans that have coupon interest rates thatadjust at least annually to more current interest rates or begin doing so after an initialfixed-rate period. After the initial fixed-rate period, if applicable, mortgage loans underlyingARM securities either (i) adjust annually based on specified margins over the one-year ConstantMaturity 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 monthlybased on specified margins over indexes such as one-month LIBOR or the Eleventh District FederalReserve 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 singleinterest rate adjustment period and over the contractual term of the loans.     As of December 31, 2007, commercial real estate loans consist of several subordinated loanstotaling $5.0 million accruing interest at 18% and scheduled to pay off in 2008 through townhomeand land sales, and $38.0 million in subordinated loans accruing interest at a margin overone-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 inSeptember 2006 Capstead formed and capitalized a series of three Delaware statutory trusts throughthe issuance to the Company of the trusts’ common securities totaling $3.1 million (see NOTE 8).The Company’s equity in the earnings of the trusts (consisting solely of the common trustsecurities’ pro rata share in interest accruing on *Unsecured borrowings*issued to the trusts)totaled $259,000, $212,000 and $30,000 during the three years ended December 31, 2007,respectively.     On November 9, 2007 Capstead acquired for $4.0 million the remaining 25% outside interest inRedtail Capital Partners, L.P., a commercial real estate loan limited partnership. BeginningNovember 10, 2007, the Company ceased accounting for the venture as an unconsolidated affiliate andconsolidated its assets and liabilities which consisted primarily of an existing $38.0 million incommercial real estate loans and a related $21.0 million in secured borrowings. The Company’sequity in this venture’s earnings (losses) while accounted for as an unconsolidated affiliatetotaled $1.5 million, $2.2 million and ($40,000) during the three years ended December 31, 2007,respectively.
13

 
Capstead Mortgage Corporation**NOTE 6 — SALE OF DISCONTINUED OPERATION**     On December 30, 2005 Capstead sold a portfolio of senior living facilities to an affiliate ofBrookdale Senior Living Inc. (NYSE: BKD), an affiliate of Fortress Investment Group LLC (NYSE:FIG), which provided management services to Capstead from April 2000 through July 2003. BKD hadoperated the properties under a net-lease arrangement since Capstead acquired the portfolio in2002. The sale generated net cash proceeds to Capstead of $54.5 million and resulted in a gain of$38.2 million, net of $2.8 million in taxes. Through the utilization of available tax attributes,including a capital loss carryforward expiring December 31, 2005, Capstead retained the resultinggain.**NOTE 7 — REPURCHASE ARRANGEMENTS AND SIMILAR****BORROWINGS, INCLUDING RELATED HEDGING ACTIVITY**     Capstead generally pledges its *Mortgage securities and similar investments*as collateral underuncommitted repurchase arrangements with well-established investment banking firms, the terms andconditions of which are negotiated on a transaction-by-transaction basis. Interest rates on theseborrowings are generally based on a margin over the federal funds rate or a corresponding interestrate for longer-term borrowings and amounts available to be borrowed are dependent upon the fairvalue 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 realestate industries. In response to declines in fair value of pledged securities, lenders mayrequire the Company to post additional collateral or pay down borrowings to re-establish agreedupon collateral requirements, referred to as margin calls. The commercial real estate loanborrowing accrues interest at a margin over one-month LIBOR and matures in three equal installmentson February 1, May 1, and August 1, 2008. The maturity of outstanding structured financings isdirectly affected by the rate of principal prepayments on the related Non-agency Securities pledgedas collateral and are currently subject to redemption by the residual bondholders. *Repurchasearrangements and similar borrowings*, classified by type of collateral and maturities, and relatedweighted average interest rates were as follows (dollars in thousands):                   ***December 31, 2007***  ***December 31, 2006***   ***Borrowings***  ***Average***  ***Borrowings***  ***Average*** ***Collateral Type*** ***Outstanding***  ***Rate******  ***Outstanding***  ***Rate******                    Borrowings with maturities of 30 days or less:                Agency Securities $4,963,674   4.93% $2,048,151   5.30%Residential mortgage loans  14,352   6.12   45,764   5.85                   4,978,026   4.93   2,093,915   5.32                                 Borrowings with maturities greater than 30 days:                Agency Securities (31 to 90 days)  —   —   1,741,751   5.16 Agency Securities (91 to 360 days)  368,694   4.92   —   — Agency Securities (greater than 360 days)  1,127,420   5.05   1,034,673   4.98                   1,496,114   5.02   2,776,424   5.09                  Similar borrowings:                Commercial real estate loans  20,974   6.88   —   — Collateral for structured financings  5,248   8.14   5,795   7.58                  $6,500,362   4.96  $4,876,134   5.19                 *** *Average rate is presented as of the indicated balance sheet date and does not include theeffects of interest rate swap agreements held as cash flow hedges on a designated portion of30-day borrowings (see below). After giving effect to these cash flow hedges, the Averagerate was 4.47% at December 31, 2007.*
14

 
Capstead Mortgage Corporation     Prior to changes in market conditions during the fall of 2007, Capstead made use oflonger-dated repurchase arrangements to effectively lock in financing spreads on a portion of itsinvestments in longer-to-reset ARM Agency Securities for a significant portion of the fixed-rateterms of these investments. As of December 31, 2007, these longer-term committed borrowingsconsisted of a series of repurchase arrangements totaling $1.50 billion with remaining terms offrom nine to 20 months and an average maturity of 15 months. Capstead had $82 million of itscapital at risk with its largest single counterparty (Cantor Fitzgerald & Company) related to $1.42billion 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. By December 31, 2007the Company had entered into five swap agreements with an aggregate notional amount of $900million, an average remaining term of 23 months and an average fixed-rate of 4.03%.     The interest rate swap agreements have been designated as cash flow hedges of the variabilityof the underlying benchmark interest rate of certain current and forecasted 30-day repurchasearrangements. This hedge relationship in effect establishes a relatively stable fixed borrowingrate on the designated borrowings with the variable-rate payments to be received on the swapagreements generally offsetting the interest owed on the designated borrowings that reset monthlyto market rates, leaving the fixed-rate payments to be paid on the swap agreements as the Company’seffective borrowing rate, subject to certain adjustments.     As of December 31, 2007, a liability for $2,384,000 was recorded on the balance sheetrepresenting the fair value of the swap agreements at year-end. Included in *Other revenue(expense)*is a holding gain of $119,000 realized prior to designating certain of these agreementsas cash flow hedges and included in *Accumulated other comprehensive income*are gross unrealizedlosses of $2,748,000 and gross unrealized gains of $243,000 incurred while the swap agreements weredesignated as cash flow hedges. During 2007 the Company’s swap agreements reduced *Interest expenseon repurchase arrangements and similar borrowings*by $903,000 consisting of net accrued cash flowsof $901,000 and measured hedge ineffectiveness of $2,000.     The weighted average effective interest rate on *Repurchase arrangements and similar borrowings*was 5.12% and 4.92% during 2007 and 2006, respectively including the effects of the swapagreements. The weighted average maturity of these borrowings was 4.2 months at December 31, 2007,with an average effective repricing period of 6.3 months including the effects of the interest rateswap agreements. Related interest paid totaled $264.1 million, $214.9 million, and $101.1 millionduring 2007, 2006 and 2005, respectively.**NOTE 8 — 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 ofthe trusts’ common securities to Capstead and to privately place $100 million of preferredsecurities with unrelated third party investors. Included in *Receivables and other assets*are $2.8million in remaining issue costs associated with these transactions.
15

 
Capstead Mortgage Corporation     Note balances and related weighted average interest rates as of December 31, 2007 and 2006(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 ratesof 8.19% to 8.685% for ten years from issuance and subsequently at prevailing three-month LIBORrates plus 3.30% to 3.50% for 20 years, reset quarterly. The trusts remit dividends pro rata tothe common and preferred trust securities based on the same terms as the subordinated notesprovided that payments on the trusts’ common securities are subordinate to payments on the relatedpreferred securities. The Capstead Mortgage Trust I notes and trust securities mature in October2035 and are redeemable, in whole or in part, without penalty, at the Company’s option anytime onor after October 30, 2010. The Capstead Mortgage Trust II notes and trust securities mature inDecember 2035 and are redeemable, in whole or in part, without penalty, at the Company’s optionanytime on or after December 15, 2015. The Capstead Mortgage Trust III notes and trust securitiesmature in September 2036 and are redeemable, in whole or in part, without penalty, at the Company’soption anytime on or after September 15, 2016.     The weighted average effective interest rate for *Unsecured borrowings*(calculated includingissue cost amortization) was 8.49% and 8.38% for the periods outstanding during 2007 and 2006,respectively. Related interest paid totaled $8,641,000, $6,987,000 and $279,000 during 2007, 2006and 2005, respectively.**NOTE 9 — DISCLOSURES REGARDING FAIR VALUES****OF FINANCIAL INSTRUMENTS**     The following tables and related discussion provide fair value disclosures as of the indicatedbalance sheet dates for Capstead’s financial assets and liabilities, most of which are influencedby changes in, and market expectations for changes in, interest rates and market liquidityconditions, as well as other factors beyond the control of management. Excluded from thesedisclosures are financial instruments for which the Company’s cost basis is deemed to approximatefair value due primarily to the short duration of these instruments, including *Cash and cashequivalents*, receivables, payables and repurchase arrangements with initial terms of less than 60days. Also excluded from these disclosures are borrowings under structured financings because theCompany holds no economic interest in these securitizations.     Fair values of *Mortgage securities and similar investments*were estimated considering recenttrading activity for similar investments and pricing levels indicated by lenders in connection withdesignating collateral for repurchase arrangements, provided such pricing levels are consideredindicative of actual market clearing transactions. Fair values of borrowings under repurchasearrangements with initial terms of greater than 60 days, commercial real estate loan borrowings,*Unsecured borrowings*, and interest rate swap agreements were estimated based on offer prices forsimilar financial instruments or market positions.
16

 
Capstead Mortgage Corporation     Fair value disclosures related to financial instruments other than mortgage securitiesclassified as available-for-sale or held-to-maturity were as follows (in thousands):                   ***December 31, 2007***  ***December 31, 2006***   ***Carrying***  ***Fair***  ***Carrying***  ***Fair***   ***Amount***  ***Value***  ***Amount***  ***Value***                    Financial Assets:                Residential mortgage loans $18,602  $18,860  $—  $— Commercial real estate loans  42,996   42,248   2,635   2,635 Financial Liabilities:                Repurchase arrangements with initialterms of greater than 60 days  1,496,114   1,514,143   1,244,744   1,241,775 Commercial real estate loanborrowing  20,974   21,364   —   — Unsecured borrowings  103,095   91,404   103,095   102,485 Interest rate swap agreements  2,384   2,384   —   —      Fair value disclosures for mortgage securities classified as available-for-sale were asfollows (in thousands):                       ***Gross***  ***Gross***          ***Unrealized***  ***Unrealized***  ***Fair***   ***Basis***  ***Gains***  ***Losses***  ***Value***                    ***As of December 31, 2007***                Agency Securities $6,989,619  $42,023  $2,611  $7,029,031 ***As of December 31, 2006***                Agency Securities $5,160,508  $25,160  $8,209  $5,177,459 Non-agency Securities  25,292   334   6   25,620                $5,185,800  $25,494  $8,215  $5,203,079                   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 December 31, 2007***                Collateral released from structuredfinancings:                Agency Securities $12,842  $340  $—  $13,182 Collateral for structured financings  5,248   —   —   5,248                $18,090  $340  $—  $18,430              ***As of December 31, 2006***                Collateral released from structuredfinancings:                Agency Securities $16,542  $306  $1  $16,847 Non-agency Securities  24,348   328   15   24,661 Collateral for structured financings  5,795   —   —   5,795                $46,685  $634  $16  $47,303                   In connection with the portfolio restructuring described below, during 2007 Capstead sold a totalof $850.5 million in *Mortgage securities and similar investments*for a net realized loss of over$5.3 million and incurred an additional loss of $2.3 million from terminating related longer-datedrepurchase arrangements. These sales included (i) $832.0 million in ARM Agency Securitiesclassified as available-for-sale for gross realized losses of
17

 
Capstead Mortgage Corporation$6.2 million and gross realized gains of $492,000, (ii) $9.3 million in residential mortgage loansunderlying Non-agency Securities classified as available-for-sale for gross realized gains of$186,000, and (iii) $9.1 million in loans underlying Non-agency Securities classified asheld-to-maturity for gross realized gains of $151,000. In connection with these sales, theremaining Non-agency Securities held by the Company were dissolved and the underlying residentialmortgage loans were classified as whole loans on the Company’s balance sheet. The loans previouslyheld as Non-agency Securities classified as held-to-maturity were originally collateral releasedfrom structured financings that had paid down to within 10% of the securitizations’ originalissuance amounts. No securities were sold in 2006 or 2005.     Additional required disclosures for *Mortgage securities and similar investments*in anunrealized loss position were as follows (in thousands):                   ***December 31, 2007***  ***December 31, 2006***   ***Fair***  ***Unrealized***  ***Fair***  ***Unrealized***   ***Value***  ***Loss***  ***Value***  ***Loss***                    Securities in an unrealized loss position:                One year or greater $323,751  $1,856  $837,123  $6,392 Less than one year  382,482   755   487,144   1,839                $706,233  $2,611  $1,324,267  $8,231              Commercial and residential loans inan unrealized loss position:                One year or greater $—  $—  $—  $— Less than one year  42,248   748   —   —                $42,248  $748  $—  $—                   Managing a large portfolio of primarily ARM Agency Securities remains the core focus ofCapstead’s investment strategy and management expects these securities will be held to maturityabsent a major shift in the Company’s investment focus. By focusing on investing in relativelyshort-duration and highly liquid ARM Agency Securities, declines in fair value caused by increasesin interest rates are typically relatively modest compared to investments in longer-durationassets. These declines can be recovered in a relatively short period of time as the couponinterest rates on the underlying mortgage loans reset to rates more reflective of the then currentinterest rate environment or prepay. Consequently, any such declines in value generally would notconstitute other-than-temporary impairments in value necessitating impairment charges. From acredit risk and market liquidity perspective, the real or implied United States governmentguarantee associated with Agency Securities helps ensure that fluctuations in value due toperceived credit risk will be relatively modest and financing will remain available via repurchasearrangements.     During the sharp contraction in market liquidity that began in August 2007, the Companyexperienced greater than anticipated margin calls due to declines in market value of pledged assetsthat were exacerbated by perceptions on the part of some lenders that values had declined evenfurther. While the Company met all margin calls during this period, management was concerned withthe possibility that lenders would require higher margin requirements on future 30-day borrowings.In response, the Company proactively reduced its balance sheet leverage by selling a portion of itsportfolio in order to improve its liquidity position. Although the imposition of higher marginrequirements on future borrowings have not materialized and conditions in the credit markets havesince improved, management anticipates continuing to operate with less leverage in the year to comeand has taken other steps to lessen the Company’s exposure to another period of severe marketilliquidity including increasing the number of lending counterparties that the Company routinelydoes business with and significantly bolstering the Company’s investment capital through commonequity offerings.
18

 
Capstead Mortgage Corporation     Commercial real estate loans held by Capstead also declined in value with the contraction inmarket liquidity that began in August 2007. These loans are well collateralized and are allscheduled to pay off during 2008. The Company has more than adequate resources to make scheduledretirements of the related commercial borrowings.**NOTE 10 — INCOME TAXES**     Capstead REIT and any subsidiaries for which the Company has elected taxable REIT subsidiarystatus file separate federal and state income tax returns, where applicable. Provided CapsteadREIT remains qualified as a REIT and all its taxable income is distributed to stockholders withintime limits prescribed by the Internal Revenue Code, no income taxes are due on this income.Accordingly, no provision has been made for income taxes for Capstead REIT on income fromcontinuing operations. Taxable income of any taxable REIT subsidiaries is fully taxable andprovision is made for any resulting income taxes as necessary. Capstead’s effective tax ratediffers substantially from statutory federal income tax rates primarily due to the benefit ofCapstead REIT’s status as a REIT, as illustrated below, along with other items affecting theCompany’s effective tax rate (in thousands):               ***Year Ended December 31***   ***2007***  ***2006***  ***2005***                Income taxes computed at the federal statutory rateon income from continuing operations $8,650  $1,345  $6,018 Benefit of REIT status  (8,038)  (1,205)  (5,925)          Income taxes computed on income of taxableREIT subsidiaries  612   140   93 Change in net deferred income tax assets  (421)  (191)  (74)Other  (6)  51   (19)          Income tax provision of taxable REIT subsidiaries $185  $—  $—                Included in *Other revenue (expense)*in 2007 is a $185,000 provision for income taxes recordedby a taxable REIT subsidiary of the Company. This provision consists of state income taxes andfederal alternative minimum taxes payable totaling $32,000 as well as $153,000 of federal incometax provision recorded as an increase to *Additional paid-in capital*. Operating loss carryforwardstotaling $1.4 million, including $436,000 in operating loss carryforwards that arose through theissuance of stock compensation, were utilized during 2007 by this subsidiary to reduce its actualtaxes payable to $32,000. With the 2005 sale of its real estate held for lease, Capstead REITutilized $32.0 million of capital loss carryforwards scheduled to expire that year which eliminatedthe resulting gain on sale from 2005 distributable income. Income from discontinued operations for2005 included a provision for $2.8 million in federal and state income taxes that were paid in2006. No income taxes were paid during 2007 and 2005, respectively.     The Company or its subsidiaries file income tax returns in the U.S. federal and various statejurisdictions. With few exceptions, the Company is no longer subject to federal, state and localincome tax examinations by tax authorities for years before 2004. The Company adopted theprovisions of FIN48 on January 1, 2007. The Company determined that no material unrecognizeddeferred tax assets or liabilities existed at January 2007 and that none arose during 2007.Accordingly, FIN48 has had no impact on the Company’s financial condition or results of operations.
19

 
Capstead Mortgage Corporation     At December 31, 2007, the Company had one taxable REIT subsidiary with available taxattributes. Significant components of the taxable REIT subsidiary’s deferred income tax assets andliabilities were as follows (in thousands):           ***December 31***   ***2007***  ***2006***            Deferred income tax assets:        Alternative minimum tax credit *(a)* $1,963  $1,921 Net operating loss carryforwards *(b)*  —   354 Other  39   150           2,002   2,425          Deferred income tax liabilities  —   —        Net deferred tax assets $2,002  $2,425                 Valuation allowance *(c)* $2,002  $2,425         *(a)* *Alternative tax credit carryforwards can be utilizedto offset payment of federal income taxes on future taxable income,if any, earned by this subsidiary subject to certain limitations.* *(b)* *Excludes $3.4 million in remaining net operating losscarryforwards that arose through the issuance of stock compensationwhich expire after 2019* *(c)* *Because this subsidiary is not currently expected toearn significant amounts of taxable income, related net deferred taxassets are fully reserved at December 31, 2007.***NOTE 11 — STOCKHOLDERS’ EQUITY**     As of December 31, 2007 Capstead had two series of convertible preferred stock outstandingranking on parity with each other and ahead of the common shares in the event of liquidation.These shares are currently redeemable at the Company’s option. Dividends are payable quarterly forthe Series A shares and monthly for the Series B shares. Under the terms of the governing ArticlesSupplementary, common dividend distributions in excess of available quarterly net income result inadjustments to the conversion ratios of the preferred shares. Capstead’s preferred shares are eachentitled to cumulative fixed dividends with conversion rates in effect January 1, 2008 for theSeries A shares and December 31, 2007 for the Series B shares and redemption prices and liquidationpreferences as indicated below:                 ***Preferred*** ***Annual*** ***Conversion*** ***Redemption*** ***Liquidation******Series*** ***Dividend*** ***Rate****** ***Price*** ***Preference*** A $1.60   1.5579  $16.40  $16.40 B  1.26   0.6007   12.50   11.38  *** *Reflects the number of common shares to be received for eachpreferred share converted.*     In October 2007, Capstead completed a public offering for 11.5 million common shares at aprice of $9.75 per share, and in November 2007, the Company completed a second public offering for9.2 million common shares at a price of $10.73 per share. Together, these offerings raised $199.1million in net proceeds after underwriting discounts and offering expenses. Also during 2007 theCompany raised $8.3 million in new common equity through the issuance of 685,900 common shares intothe open market on a limited basis, at an average price of $12.13 per share, after expenses.Additions to capital related to equity awards to directors and employees totaled $910,000, $613,000and $273,000 during the three years ended December 31, 2007, respectively, including proceeds fromthe exercise of option awards of $257,000 and $98,000 during 2007 and 2006, respectively. See NOTE12 for further information pertaining to long-term incentive plans.
20

 
Capstead Mortgage Corporation     Subsequent to year-end, Capstead completed a third public offering for an additional 8.6million common shares at a price of $15.50 per share, raising $127 million in net proceeds, afterunderwriting discounts and offering expenses. The accompanying December 31, 2007 financialstatements and related disclosures do not reflect this latest offering of shares.     Comprehensive income is net income plus other comprehensive income (loss). Othercomprehensive income (loss) currently consists of the change in unrealized gain on mortgagesecurities classified as available-for-sale and amounts related to Derivatives held as cash flowhedges. As of December 31, 2007, the *Accumulated other comprehensive income*component of*Stockholders’ equity*consisted of $39.4 million in net unrealized gains on mortgage securities heldavailable-for-sale, $2.5 million in net unrealized losses on Derivatives held as cash flow hedgesand $54,000 in amounts related to terminated cash flow hedges. The following provides informationregarding the components of comprehensive income (in thousands):               ***Year Ended December 31***   ***2007***  ***2006***  ***2005***   Net income $24,713  $3,843  $57,192           Other comprehensive income (loss):            Amounts related to cash flow hedges:            Change in net unrealized losses  (2,505)  —   — Reclassification adjustment for amountsincluded in net income  (103)  (55)  (118)Amounts related to discontinued operation  —   —   521 Amounts related to available-for-sale securities:            Reclassification adjustments for amountsincluded in net income  5,348   —   — Change in net unrealized gains  16,785   12,495   (19,239)          Other comprehensive income (loss)  19,525   12,440   18,836)          Comprehensive income $44,238  $16,283  $38,356                Capstead’s Charter provides that if the board of directors determines in good faith that thedirect or indirect ownership of the common shares has become concentrated to an extent which wouldcause Capstead REIT to fail to qualify as a REIT, the Company may redeem or repurchase, at fairmarket value, any number of common or preferred shares sufficient to maintain or bring suchownership into conformity with the Code. In addition, the Company may refuse to transfer or issuecommon or preferred shares to any person whose ownership of the shares would result in CapsteadREIT being unable to comply with the requirements of the Internal Revenue Code. Finally, theCharter provides that the Company may redeem or refuse to transfer any shares of Capstead toprevent the imposition of a penalty tax as a result of ownership of such shares by certaindisqualified organizations, including governmental bodies and tax-exempt entities that are notsubject to tax on unrelated business taxable income.**NOTE 12 — 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 December 31, 2007, the Plans had 1,757,957 common shares remaining available forfuture issuance.
21

 
Capstead Mortgage Corporation     The Company also sponsors a qualified defined contribution retirement plan for all employeesand a nonqualified deferred compensation plan for certain of its officers. In general the Companymatches up to 50% of a participant’s voluntary contribution up to a maximum of 6% of aparticipant’s compensation and discretionary contributions of up to another 3% of compensationregardless of participation in the plans. All Company contributions are subject to certain vestingrequirements. Contribution expenses were $81,000, $113,000 and $236,000 in 2007, 2006 and 2005,respectively.     In May and June 2005 stock awards for a total of 172,600 common shares were issued todirectors and employees (average grant date fair value: $7.86 per share) that vest in four annualinstallments, subject to certain restrictions, including continuous service. In December 2006stock 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 tosimilar restrictions. Also during 2006, stock awards for 21,457 common shares were issued to a newemployee and certain directors (average grant date fair value: $6.86 per share), 6,457 shares ofwhich were vested at grant with the remaining shares vesting proportionally over three years,subject to similar restrictions. Stock award activity during the year ended December 31, 2007 issummarized below:               ***Weighted Average***  ***Number of*** ***Grant Date***  ***Shares*** ***Fair Value***  Stock awards outstanding as of December 31, 2006  321,550  $8.02 Grants ***  156,000   12.93 Forfeitures  (6,250)  7.97 Vested  (40,100)  7.74          Stock awards outstanding as of December 31, 2007  431,200   9.82           *** *In May 2007, stock awards totaling 6,000 common shares were issued todirectors that vest April 15, 2008 (grant date fair value $9.81). In December2007, stock awards totaling 150,000 common shares were issued to employees thatvest in six annual installments beginning January 2, 2009 (grant date fair value$13.05). These grants are subject to certain restrictions, including continuousservice.*     Option awards currently outstanding have contractual terms and vesting requirements at thegrant date of up to ten years and generally have been issued with strike prices equal to the quotedmarket prices of the Company’s common shares on the date of grant. The fair value of each optionaward is estimated on the date of grant using a Black-Scholes option pricing model. The Companyestimates option exercises, expected holding periods and forfeitures based on past experience andcurrent expectations for option performance and employee/director attrition. The risk-free rate isbased on market rates for the expected life of the option. Expected dividends are based onhistorical experience and expectations for future performance. In measuring volatility factors inrecent years, the Company considered volatilities experienced by certain other companies in themortgage REIT industry in addition to historical volatilities of Capstead shares given pastcircumstances affecting the trading of Capstead shares not expected to reoccur.     During 2005 option awards granted to directors and employees totaled 430,000 shares with anaverage price of $7.85 and an average fair value of $0.61 per share, which was determined usingaverage expected terms of four years, volatility factors of 27%, dividend yields of 10% andrisk-free rates of 3.76%. During 2006 option awards granted to directors and employees totaled258,000 shares with an average price of $7.43 and an average fair value of $0.78 per share, whichwas determined using average expected terms of four years, volatility factors of 31%, dividendyields of 10% and risk-free rates of 4.91%.
22

 
Capstead Mortgage Corporation     Option award activity during the year ended December 31, 2007 is summarized below:           ***Number of***  ***Weighted Average***   ***Shares***  ***Exercise Price***   Option awards outstanding as of December 31, 2006  855,552  $13.02 Grants (average fair value $0.89) ***  220,500   10.46 Forfeitures  (42,944)  13.31 Expirations  (53,520)  33.77 Exercises  (30,932)  6.05        Option awards outstanding as of December 31, 2007  948,656  $11.47         *** *Option awards granted during 2007 to directors and employees were valued withaverage expected terms of four years, volatility factors of 27%, dividend yields of10% and risk-free rates of 4.60%.*     The weighted average remaining contractual term, average exercise price and aggregateintrinsic value for the 438,906 exercisable option awards outstanding as of December 31, 2007 wasfive years, $14.52 and $1.7 million, respectively. The total intrinsic value of option awardsexercised during 2007 and 2006 was $133,000 and $5,000, respectively. There were no exercises ofoption awards in 2005. Unrecognized compensation costs for all unvested equity awards totaled $3.9million as of December 31, 2007, to be expensed over a weighted average period of three years.**NOTE 13 — NET INTEREST INCOME ANALYSIS (UNAUDITED)**     The following summarizes interest income, interest expense and weighted average interestrates, as restated for the reclassification of other interest income and interest expense onunsecured borrowings — see NOTE 16 (dollars in thousands):                           ***2007, as Restated***  ***2006, as Restated***  ***2005, as Restated***       ***Average***      ***Average***      ***Average***       ***Effective***      ***Effective***      ***Effective***   ***Amount***  ***Rate***  ***Amount***  ***Rate***  ***Amount***  ***Rate***                           Interest income:                        Mortgage securities andsimilar investments $310,698   5.64% $242,859   4.94% $130,333   3.68%Other  945   4.76   413   4.79   332   3.09                          311,643   5.64   243,272   4.94   130,665   3.68                                                Interest expense:                        Repurchasearrangements andsimilar borrowings  (266,901)  5.12   (228,379)  4.92   (105,937)  3.17 Unsecured borrowings  (8,747)  8.49   (7,142)  8.38   (972)  8.37                          (275,648)  5.19   (235,521)  4.98   (106,909)  3.19                         $35,995   0.45  $7,751   (0.04) $23,756   0.49                       
23

 
Capstead Mortgage Corporation     Related changes in interest income and interest expense due to changes in interest ratesversus changes in volume were as follows (in thousands):               ***Rate******  ***Volume******  ***Total******   ***(as Restated, see NOTE 16)***     ***2007/2006***            Interest income:            Mortgage securities and similar investments $36,661  $31,178  $67,839 Other  (3)  535   532              36,658   31,713   68,371                        Interest expense:            Repurchase arrangements and similar borrowings  9,437   29,085   38,522 Unsecured borrowings  95   1,510   1,605              9,532   30,595   40,127             $27,126  $1,118  $28,244                        ***2006/2005***            Interest income:            Mortgage securities and similar investments $52,702  $59,824  $112,526 Other  156   (75)  81              52,858   59,749   112,607                        Interest expense:            Repurchase arrangements and similar borrowings  70,768   51,674   122,442 Unsecured borrowings  1   6,169   6,170              70,769   57,843   128,612             $(17,911) $1,906  $(16,005)           *** *The change in interest income and interest expense due to both volume and rate has beenallocated to volume and rate changes in proportion to the relationship of the absolutedollar amounts of the change in each****.*****NOTE 14 — MARKET AND DIVIDEND INFORMATION (UNAUDITED)**     The New York Stock Exchange trading symbol for Capstead’s common shares is CMO. As of December31, 2007, the Company had 1,659 common stockholders of record and depository companies held commonshares for 16,550 beneficial owners. The high and low sales prices and dividends declared on thecommon shares were as follows:                           ***Year Ended December 31, 2007*** ***Year Ended December 31, 2006***  ***Sales Prices***  ***Dividends***  ***Sales Prices*** ***Dividends***  ***High*** ***Low*** ***Declared*** ***High*** ***Low*** ***Declared***  First quarter $10.02  $7.75  $0.02  $7.66  $6.30  $0.02 Second quarter  10.73   9.01   0.04   8.10   6.56   0.02 Third quarter  10.68   8.01   0.04   8.75   6.77   0.02 Fourth quarter  13.84   10.06   0.24   8.70   7.82   0.02 
24

 
Capstead Mortgage Corporation**NOTE 15 — QUARTERLY RESULTS (UNAUDITED)**     Summarized quarterly results of operations were as follows (in thousands, except per shareamounts).                   ***1******st******Quarter***  ***2******nd******Quarter***  ***3******rd******Quarter***  ***4******th******Quarter***       ***(as Restated, see NOTE 16)***                 ***Year Ended December 31, 2007***                Interest income $72,204  $75,834  $75,161  $88,444 Interest expense  (65,776)  (69,294)  (68,664)  (71,914)                6,428   6,540   6,497   16,530 Gain (loss) from portfolio restructuring  —   —   (8,276)  593 Other revenue (expense)  (865)  (1,341)  (1,616)  (1,560)Equity in earnings of unconsolidated affiliates  664   575   247   297              Net income (loss) $6,227  $5,774  $(3,148) $15,860                               Basic and diluted income (loss) per commonshare $0.06  $0.04  $(0.43) $0.31                               ***Year Ended December 31, 2006***                Interest income $53,046  $57,451  $62,276  $70,499 Interest expense  (49,130)  (56,306)  (62,813)  (67,272)                3,916   1,145   (537)  3,227 Other revenue (expense)  (1,627)  (1,478)  (1,610)  (1,561)Equity in earnings of unconsolidated affiliates  422   608   654   684              Net income (loss) $2,711  $275  $(1,493) $2,350                               Basic and diluted loss per common share $(0.12) $(0.25) $(0.35) $(0.14)             **NOTE 16 — RESTATEMENT TO RECLASSIFY INTEREST INCOME,**