##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended: June 30, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from ___to ___
 Commission File Number: 1-8996
 CAPSTEAD MORTGAGE CORPORATION
  Maryland
(State or other jurisdiction of
incorporation or organization)
    
    75-2027937
(I.R.S. Employer
Identification No.)
 8401 North Central Expressway, Suite 800, Dallas, TX
(Address of principal executive offices)
    
    75225
(Zip Code)
 (214) 874-2323
 þ o
 þ o
 APPLICABLE ONLY TO CORPORATE ISSUERS:
  Common Stock ($0.01 par value)
    
    19,043,297 as of July 29, 2005




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##### Table of Contents



CAPSTEAD
MORTGAGE CORPORATION
 FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2005
 INDEX
  
 PagePART I. 3⁄4 FINANCIAL INFORMATIONITEM 1. Financial StatementsConsolidated Balance Sheets 3⁄4 June 30, 2005 and December 31, 2004
    
    
    3Consolidated Statements of Operations 3⁄4 Quarter and Six Months Ended June 30, 2005 and 2004
    
    
    4Consolidated Statements of Cash Flows 3⁄4 Six Months Ended June 30, 2005 and 2004
    
    
    5Notes to Consolidated Financial Statements
    
    
    6ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16ITEM 3. Qualitative and Quantitative Disclosure of Market Risk
    
    
    33ITEM 4. Controls and Procedures
    
    
    33PART II. 3⁄4 OTHER INFORMATIONITEM 5. Other Information
    
    
    33ITEM 6. Exhibits and Reports on Form 8-K
    
    
    34SIGNATURES
    
    
    35Form of Master AgreementForms of Non-Qualified Stock Option & Restricted Stock Agreements - Non-EmployeeForms of Non-Qualified Stock Option & Restricted Stock Agreements - Employees2005 Non-Qualified Stock OptionComputation of Ratio of Earnings to Combined Fixed ChargesCertification Pursuant to Section 302Certification Pursuant to Section 302Certification Pursuant to Section 906
 -2-




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ITEM 1. FINANCIAL STATEMENTS
 
 PART I. 3⁄4 FINANCIAL INFORMATION
 CAPSTEAD MORTGAGE CORPORATION
 
 CONSOLIDATED BALANCE SHEETS
 (in thousands, except per share amounts)
 June 30, 2005
    
    December 31, 2004(unaudited)
    
    (NOTE 2)AssetsMortgage securities and similar investments
($3.4 billion pledged under repurchase arrangements in 2005)
    
    $
    3,486,161
    
    
    $
    3,382,372CMO collateral
    
    
    22,657
    
    
    
    56,1873,508,818
    
    
    
    3,438,559Real estate held for lease, net of accumulated depreciation
    
    
    127,851
    
    
    
    129,705Receivables and other assets
    
    
    52,873
    
    
    
    46,688Cash and cash equivalents
    
    
    181
    
    
    
    73,030$
    3,689,723
    
    
    $
    3,687,982LiabilitiesRepurchase arrangements and similar borrowings
    
    $
    3,206,954
    
    
    $
    3,166,059Collateralized mortgage obligations (CMOs)
    
    
    22,366
    
    
    
    55,735Borrowings secured by real estate
    
    
    119,884
    
    
    
    120,001Common stock dividend payable
    
    
    1,903
    
    
    
    4,151Accounts payable and accrued expenses
    
    
    10,074
    
    
    
    9,4973,361,181
    
    
    
    3,355,443Stockholders equityPreferred stock  $0.10 par value; 100,000 shares authorized:$1.60 Cumulative Preferred Stock, Series A,
202 shares issued and outstanding at
June 30, 2005 and December 31, 2004
($3,317 aggregate liquidation preference)
    
    
    2,827
    
    
    
    2,827$1.26 Cumulative Convertible Preferred Stock, Series B,
15,819 shares issued and outstanding at
June 30, 2005 and December 31, 2004
($180,025 aggregate liquidation preference)
    
    
    176,705
    
    
    
    176,705Common stock  $0.01 par value; 100,000 shares authorized;
19,043 and 18,867 shares issued and outstanding at
June 30, 2005 and December 31, 2004, respectively
    
    
    191
    
    
    
    189Paid-in capital
    
    
    514,969
    
    
    
    516,704Accumulated deficit
    
    
    (387,718
    )
    
    
    (387,718
    )Accumulated other comprehensive income
    
    
    21,568
    
    
    
    23,832328,542
    
    
    
    332,539$
    3,689,723
    
    
    $
    3,687,982
 See accompanying notes to consolidated financial statements.
 -3-




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CAPSTEAD MORTGAGE CORPORATION
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (in thousands, except per share amounts)
 (unaudited)
 Quarter Ended
    
    Six Months EndedJune 30
    
    June 302005
    
    2004
    
    2005
    
    2004Interest income:Mortgage securities and similar investments
    
    $
    30,214
    
    
    $
    19,279
    
    
    $
    58,395
    
    
    $
    38,716CMO collateral
    
    
    375
    
    
    
    1,866
    
    
    
    717
    
    
    
    4,372Total interest income
    
    
    30,589
    
    
    
    21,145
    
    
    
    59,112
    
    
    
    43,088Interest and related expense:Repurchase arrangements and similar borrowings
    
    
    23,445
    
    
    
    6,967
    
    
    
    43,185
    
    
    
    12,797CMO borrowings
    
    
    303
    
    
    
    1,659
    
    
    
    546
    
    
    
    3,952Mortgage insurance and other
    
    
    46
    
    
    
    67
    
    
    
    96
    
    
    
    114Total interest and related expense
    
    
    23,794
    
    
    
    8,693
    
    
    
    43,827
    
    
    
    16,863Net margin on financial assets
    
    
    6,795
    
    
    
    12,452
    
    
    
    15,285
    
    
    
    26,225Real estate lease income
    
    
    2,890
    
    
    
    2,434
    
    
    
    5,540
    
    
    
    4,959Real estate-related expense:Interest
    
    
    1,501
    
    
    
    1,061
    
    
    
    2,778
    
    
    
    2,146Depreciation
    
    
    927
    
    
    
    927
    
    
    
    1,854
    
    
    
    1,854Total real estate-related expense
    
    
    2,428
    
    
    
    1,988
    
    
    
    4,632
    
    
    
    4,000Net margin on real estate held for lease
    
    
    462
    
    
    
    446
    
    
    
    908
    
    
    
    959Other revenue (expense):Other revenue
    
    
    215
    
    
    
    249
    
    
    
    411
    
    
    
    316Other operating expense
    
    
    (1,482
    )
    
    
    (1,332
    )
    
    
    (3,012
    )
    
    
    (3,331
    )Total other revenue (expense)
    
    
    (1,267
    )
    
    
    (1,083
    )
    
    
    (2,601
    )
    
    
    (3,015
    )Net income
    
    $
    5,990
    
    
    $
    11,815
    
    
    $
    13,592
    
    
    $
    24,169Net income
    
    $
    5,990
    
    
    $
    11,815
    
    
    $
    13,592
    
    
    $
    24,169Less cash dividends paid on preferred shares
    
    
    (5,064
    )
    
    
    (5,064
    )
    
    
    (10,128
    )
    
    
    (10,131
    )Net income available to common stockholders
    
    $
    926
    
    
    $
    6,751
    
    
    $
    3,464
    
    
    $
    14,038Net income per common share:Basic
    
    $
    0.05
    
    
    $
    0.44
    
    
    $
    0.18
    
    
    $
    0.95Diluted
    
    
    0.05
    
    
    
    0.44
    
    
    
    0.18
    
    
    
    0.94Cash dividends declared per share:Common
    
    $
    0.100
    
    
    $
    0.500
    
    
    $
    0.280
    
    
    $
    1.030Series A Preferred
    
    
    0.400
    
    
    
    0.400
    
    
    
    0.800
    
    
    
    0.800Series B Preferred
    
    
    0.315
    
    
    
    0.315
    
    
    
    0.630
    
    
    
    0.630
 See accompanying notes to consolidated financial statements.
 -4-




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CAPSTEAD MORTGAGE CORPORATION
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 (unaudited)
 Six Months EndedJune 302005
    
    2004Operating activities:Net income
    
    $
    13,592
    
    
    $
    24,169Noncash items:Amortization of discount and premium
    
    
    10,131
    
    
    
    5,510Depreciation and other amortization
    
    
    2,238
    
    
    
    2,302Net change in receivables, other assets,
accounts payable and accrued expenses
    
    
    (3,586
    )
    
    
    (2,942
    )Net cash provided by operating activities
    
    
    22,375
    
    
    
    29,039Investing activities:Purchases of mortgage securities and similar investments
    
    
    (710,966
    )
    
    
    (787,353
    )Principal collections on mortgage securities
and similar investments
    
    
    592,442
    
    
    
    350,408CMO collateral:Principal collections
    
    
    32,690
    
    
    
    61,358Decrease in accrued interest receivable
    
    
    242
    
    
    
    392Net cash used in investing activities
    
    
    (85,592
    )
    
    
    (375,195
    )Financing activities:Net increase in repurchase arrangements
and similar borrowings
    
    
    40,895
    
    
    
    410,893Principal payments on borrowings secured by real estate
    
    
    (117
    )
    
    
    (105
    )CMO borrowings:Principal payments on securities
    
    
    (32,543
    )
    
    
    (60,975
    )Decrease in accrued interest payable
    
    
    (217
    )
    
    
    (364
    )Capital stock transactions
    
    
    26
    
    
    
    30,314Dividends paid
    
    
    (17,676
    )
    
    
    (26,767
    )Net cash (used in) provided by financing activities
    
    
    (9,632
    )
    
    
    352,996Net change in cash and cash equivalents
    
    
    (72,849
    )
    
    
    6,840Cash and cash equivalents at beginning of period
    
    
    73,030
    
    
    
    16,340Cash and cash equivalents at end of period
    
    $
    181
    
    
    $
    23,180
 See accompanying notes to consolidated financial statements.
 -5-




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CAPSTEAD MORTGAGE CORPORATION
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 JUNE 30, 2005
 (unaudited)
 NOTE 1 3⁄4 BUSINESS
   NOTE 2 3⁄4 BASIS OF PRESENTATION
 Interim Financial Reporting
  Stock-Based Compensation
 Other operating expense
 -6-




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NOTE 3 3⁄4 NET INCOME PER COMMON SHARE
  Quarter Ended June 30
    
    Six Months Ended June 302005
    
    2004
    
    2005
    
    2004Numerator for basic net income per common share:Net income
    
    $
    5,990
    
    
    $
    11,815
    
    
    $
    13,592
    
    
    $
    24,169Less all preferred share dividends
    
    
    (5,064
    )
    
    
    (5,064
    )
    
    
    (10,128
    )
    
    
    (10,131
    )Net income available to common stockholders
    
    $
    926
    
    
    $
    6,751
    
    
    $
    3,464
    
    
    $
    14,038Weighted average common shares outstanding
    
    
    18,869
    
    
    
    15,237
    
    
    
    18,865
    
    
    
    14,752Basic net income per common share
    
    $
    0.05
    
    
    $
    0.44
    
    
    $
    0.18
    
    
    $
    0.95Numerator for diluted net income per common share:Net income
    
    $
    5,990
    
    
    $
    11,815
    
    
    $
    13,592
    
    
    $
    24,169Less dividends on antidilutive convertible
preferred shares
    
    
    (5,064
    )
    
    
    (4,983
    )
    
    
    (10,128
    )
    
    
    (9,966
    )$
    926
    
    
    $
    6,832
    
    
    $
    3,464
    
    
    $
    14,203Denominator for diluted net income per common
share:Weighted average common shares outstanding
    
    
    18,869
    
    
    
    15,237
    
    
    
    18,865
    
    
    
    14,752Net effect of dilutive stock options
    
    
    39
    
    
    
    30
    
    
    
    40
    
    
    
    35Net effect of dilutive Series A preferred shares
    
    
    
    
    
    
    311
    
    
    
    
    
    
    
    31318,908
    
    
    
    15,578
    
    
    
    18,905
    
    
    
    15,100Diluted net income per common share
    
    $
    0.05
    
    
    $
    0.44
    
    
    $
    0.18
    
    
    $
    0.94
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NOTE 4 3⁄4 MORTGAGE SECURITIES AND SIMILAR INVESTMENTS
 Receivables and other assets
 Mortgage securities and similar investments
 Average
    
    AveragePrincipal
    
    Premiums
    
    
    
    
    
    Carrying
    
    Coupon
    
    EffectiveBalance
    
    (Discounts)
    
    Basis
    
    Amount(a)
    
    Rate(b)
    
    Rate(b)June 30, 2005Agency Securities:Fannie Mae/Freddie Mac:Fixed-rate
    
    $
    28,090
    
    
    $
    109
    
    
    $
    28,199
    
    
    $
    28,241
    
    
    
    6.62
    %
    
    
    6.23
    %ARMs
    
    
    2,313,752
    
    
    
    44,431
    
    
    
    2,358,183
    
    
    
    2,369,209
    
    
    
    4.48
    
    
    
    3.47Ginnie Mae ARMs
    
    
    945,275
    
    
    
    5,879
    
    
    
    951,154
    
    
    
    961,272
    
    
    
    3.98
    
    
    
    3.353,287,117
    
    
    
    50,419
    
    
    
    3,337,536
    
    
    
    3,358,722
    
    
    
    4.35
    
    
    
    3.46Non-agency Securities:Fixed-rate
    
    
    27,237
    
    
    
    7
    
    
    
    27,244
    
    
    
    27,281
    
    
    
    6.77
    
    
    
    6.38ARMs
    
    
    48,359
    
    
    
    487
    
    
    
    48,846
    
    
    
    49,292
    
    
    
    4.78
    
    
    
    4.3475,596
    
    
    
    494
    
    
    
    76,090
    
    
    
    76,573
    
    
    
    5.50
    
    
    
    5.08CMBS  adjustable-rate
    
    
    50,834
    
    
    
    7
    
    
    
    50,841
    
    
    
    50,866
    
    
    
    4.26
    
    
    
    4.08$
    3,413,547
    
    
    $
    50,920
    
    
    $
    3,464,467
    
    
    $
    3,486,161
    
    
    
    4.38
    
    
    
    3.51
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Average
    
    AveragePrincipal
    
    Premiums
    
    
    
    
    
    Carrying
    
    Coupon
    
    EffectiveBalance
    
    (Discounts)
    
    Basis
    
    Amount(a)
    
    Rate(b)
    
    Rate(b)December 31, 2004Agency Securities:Fannie Mae/Freddie Mac:Fixed-rate
    
    $
    35,538
    
    
    $
    146
    
    
    $
    35,684
    
    
    $
    35,739
    
    
    
    6.63
    %
    
    
    6.19
    %ARMs
    
    
    2,116,454
    
    
    
    39,572
    
    
    
    2,156,026
    
    
    
    2,170,766
    
    
    
    3.96
    
    
    
    3.11Ginnie Mae ARMs
    
    
    1,017,517
    
    
    
    7,583
    
    
    
    1,025,100
    
    
    
    1,033,506
    
    
    
    3.87
    
    
    
    3.013,169,509
    
    
    
    47,301
    
    
    
    3,216,810
    
    
    
    3,240,011
    
    
    
    3.96
    
    
    
    3.11Non-agency Securities:Fixed-rate
    
    
    34,338
    
    
    
    24
    
    
    
    34,362
    
    
    
    34,415
    
    
    
    6.78
    
    
    
    6.27ARMs
    
    
    55,615
    
    
    
    646
    
    
    
    56,261
    
    
    
    56,739
    
    
    
    4.12
    
    
    
    3.4989,953
    
    
    
    670
    
    
    
    90,623
    
    
    
    91,154
    
    
    
    5.14
    
    
    
    4.55CMBS  adjustable-rate
    
    
    51,159
    
    
    
    10
    
    
    
    51,169
    
    
    
    51,207
    
    
    
    3.44
    
    
    
    3.10$
    3,310,621
    
    
    $
    47,981
    
    
    $
    3,358,602
    
    
    $
    3,382,372
    
    
    
    3.98
    
    
    
    3.16
 
 (a)
    
    Includes mark-to-market for securities classified as available-for-sale, if applicable
(see NOTE 10).(b)
    
    Average Coupon Rate is presented net of servicing and other fees as of the indicated balance
sheet date. Average Effective Rate is presented for the quarter then ended, calculated
including the amortization of premiums (discounts), mortgage insurance costs on Non-agency
Securities and excluding unrealized gains and losses. NOTE 5 3⁄4 CMO COLLATERAL AND INVESTMENTS
 CMO collateral
 June 30, 2005
    
    December 31, 2004Non-agency Securities
    
    $
    22,178
    
    
    $
    54,996Accrued interest receivable
    
    
    148
    
    
    
    39022,326
    
    
    
    55,386Unamortized premium
    
    
    331
    
    
    
    801$
    22,657
    
    
    $
    56,187
  NOTE 6 3⁄4 REAL ESTATE HELD FOR LEASE
 
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Receivables and other assets
 June 30, 2005
    
    December 31, 2004Land
    
    $
    16,450
    
    
    $
    16,450Buildings
    
    
    119,550
    
    
    
    119,550Equipment and fixtures
    
    
    3,600
    
    
    
    3,600139,600
    
    
    
    139,600Accumulated depreciation
    
    
    (11,749
    )
    
    
    (9,895
    )$
    127,851
    
    
    $
    129,705
 NOTE 7 3⁄4 REPURCHASE ARRANGEMENTS AND SIMILAR BORROWINGS
  June 30, 2005
    
    December 31, 2004Borrowings
    
    Average
    
    Borrowings
    
    AverageOutstanding
    
    Rate
    
    Outstanding
    
    RateAgency Securities (less than 31 days)
    
    $
    2,392,050
    
    
    
    3.21
    %
    
    $
    2,340,755
    
    
    
    2.28
    %Agency Securities (31 to 90 days)
    
    
    50,803
    
    
    
    2.30
    
    
    
    54,021
    
    
    
    1.98Agency Securities (91 to 360 days)
    
    
    625,924
    
    
    
    2.52
    
    
    
    204,983
    
    
    
    2.19Agency Securities (greater than 360 days)
    
    
    30,153
    
    
    
    3.83
    
    
    
    446,744
    
    
    
    2.61Non-agency Securities (less than 31 days)
    
    
    59,914
    
    
    
    3.66
    
    
    
    71,140
    
    
    
    2.76CMBS (less than 31 days)
    
    
    48,110
    
    
    
    3.29
    
    
    
    48,416
    
    
    
    2.54$
    3,206,954
    
    
    
    3.08
    
    
    $
    3,166,059
    
    
    
    2.33
 Repurchase arrangements and similar borrowings
 -10-




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NOTE 8 3⁄4 CMO BORROWINGS
  June 30, 2005
    
    December 31, 2004CMOs
    
    $
    22,049
    
    
    $
    54,739Accrued interest payable
    
    
    75
    
    
    
    292Total obligation
    
    
    22,124
    
    
    
    55,031Unamortized premium
    
    
    242
    
    
    
    704$
    22,366
    
    
    $
    55,735Range of average interest rates
    
    3.45% to 8.44%
    
    2.29% to 9.60%Range of stated maturities
    
    2025 to 2027
    
    2025 to 2030Number of series
    
    
    3
    
    
    
    5
 CMO collateral CMO borrowings
 NOTE 9 3⁄4 BORROWINGS SECURED BY REAL ESTATE
 Borrowings secured by real estate
 June 30, 2005
    
    December 31, 2004Borrowings
    
    Average
    
    Borrowings
    
    AverageOutstanding
    
    Rate
    
    Outstanding
    
    RateMortgage borrowings
    
    $
    19,043
    
    
    
    7.92
    %
    
    $
    19,160
    
    
    
    7.92
    %Tax-exempt bonds
    
    
    100,841
    
    
    
    4.62
    
    
    
    100,841
    
    
    
    2.98$
    119,884
    
    
    
    5.15
    
    
    $
    120,001
    
    
    
    3.77
 Receivables and other assets Receivables and
other assets
 -11-




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Borrowings secured by real estate
 NOTE 10 3⁄4 DISCLOSURES REGARDING FAIR VALUES OF DEBT SECURITIES
   Gross
    
    GrossCost
    
    Unrealized
    
    Unrealized
    
    FairBasis
    
    Gains
    
    Losses
    
    ValueAs of June 30, 2005Agency Securities:Fixed-rate
    
    $
    487
    
    
    $
    42
    
    
    $
    
    
    
    $
    529ARMs
    
    
    3,309,337
    
    
    
    26,931
    
    
    
    5,787
    
    
    
    3,330,4813,309,824
    
    
    
    26,973
    
    
    
    5,787
    
    
    
    3,331,010Non-agency Securities
    
    
    35,198
    
    
    
    497
    
    
    
    14
    
    
    
    35,681CMBS
    
    
    50,841
    
    
    
    26
    
    
    
    1
    
    
    
    50,866CMO collateral
    
    
    8,778
    
    
    
    124
    
    
    
    
    
    
    
    8,902$
    3,404,641
    
    
    $
    27,620
    
    
    $
    5,802
    
    
    $
    3,426,459As of December 31, 2004Agency Securities:Fixed-rate
    
    $
    606
    
    
    $
    55
    
    
    $
    
    
    
    $
    661ARMs
    
    
    3,181,126
    
    
    
    26,467
    
    
    
    3,321
    
    
    
    3,204,2723,181,732
    
    
    
    26,522
    
    
    
    3,321
    
    
    
    3,204,933Non-agency Securities
    
    
    41,166
    
    
    
    564
    
    
    
    33
    
    
    
    41,697CMBS
    
    
    51,169
    
    
    
    39
    
    
    
    1
    
    
    
    51,207CMO collateral
    
    
    12,214
    
    
    
    253
    
    
    
    
    
    
    
    12,467$
    3,286,281
    
    
    $
    27,378
    
    
    $
    3,355
    
    
    $
    3,310,304
 -12-




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##### Table of Contents



CMO collateral
 Gross
    
    GrossCost
    
    Unrealized
    
    Unrealized
    
    FairBasis
    
    Gains
    
    Losses
    
    ValueAs of June 30, 2005Released CMO Collateral:Agency Securities
    
    $
    27,712
    
    
    $
    1,067
    
    
    $
    
    
    
    $
    28,779Non-agency Securities
    
    
    40,892
    
    
    
    876
    
    
    
    
    
    
    
    41,768CMO Collateral
    
    
    13,755
    
    
    
    44
    
    
    
    
    
    
    
    13,799$
    82,359
    
    
    $
    1,987
    
    
    $
    
    
    
    $
    84,346As of December 31, 2004Released CMO Collateral:Agency Securities
    
    $
    35,078
    
    
    $
    1,723
    
    
    $
    
    
    
    $
    36,801Non-agency Securities
    
    
    49,457
    
    
    
    1,345
    
    
    
    97
    
    
    
    50,705CMO Collateral
    
    
    43,720
    
    
    
    84
    
    
    
    
    
    
    
    43,804$
    128,255
    
    
    $
    3,152
    
    
    $
    97
    
    
    $
    131,310
  NOTE 11 3⁄4 COMPREHENSIVE INCOME (LOSS)
  Quarter Ended
    
    Six Months EndedJune 30
    
    June 302005
    
    2004
    
    2005
    
    2004Net income
    
    $
    5,990
    
    
    $
    11,815
    
    
    $
    13,592
    
    
    $
    24,169Other comprehensive income (loss):Unrealized loss on derivative financial
Instruments held as cash flow hedges:Change in unrealized loss during period
    
    
    13
    
    
    
    (50
    )
    
    
    3
    
    
    
    (178
    )Reclassification adjustment for amounts
included in net income
    
    
    (25
    )
    
    
    (30
    )
    
    
    (62
    )
    
    
    (81
    )(12
    )
    
    
    (80
    )
    
    
    (59
    )
    
    
    (259
    )Unrealized gain on debt securities:Change in unrealized gain during period
    
    
    2,916
    
    
    
    (14,117
    )
    
    
    (2,205
    )
    
    
    (11,445
    )Other comprehensive income (loss)
    
    
    2,904
    
    
    
    (14,197
    )
    
    
    (2,264
    )
    
    
    (11,704
    )Comprehensive income (loss)
    
    $
    8,894
    
    
    $
    (2,382
    )
    
    $
    11,328
    
    
    $
    12,465
 -13-




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##### Table of Contents



NOTE 12 3⁄4 NET INTEREST INCOME ANALYSIS
 Real estate held for
lease
 Quarter Ended June 302005
    
    2004Average
    
    
    
    AverageAmount
    
    Rate
    
    Amount
    
    RateInterest income:Mortgage securities and other investments
    
    $
    30,214
    
    
    
    3.51
    %
    
    $
    19,279
    
    
    
    3.10
    %CMO collateral
    
    
    375
    
    
    
    5.76
    
    
    
    1,866
    
    
    
    6.46Total interest income
    
    
    30,589
    
    
    
    
    
    
    
    21,145Interest expense:Repurchase arrangements and similar
borrowings
    
    
    23,445
    
    
    
    2.91
    
    
    
    6,967
    
    
    
    1.20CMO borrowings
    
    
    303
    
    
    
    4.67
    
    
    
    1,659
    
    
    
    5.74Total interest expense
    
    
    23,748
    
    
    
    
    
    
    
    8,626$
    6,841
    
    
    
    
    
    
    $
    12,519
 Six Months Ended June 302005
    
    2004Amount
    
    Average
    
    Amount
    
    AverageInterest income:Mortgage securities and similar investments
    
    $
    58,395

    
    
    
    3.42
    %
    
    $
    38,716
    
    
    
    3.25
    %CMO collateral
    
    
    717
    
    
    
    4.13
    
    
    
    4,372
    
    
    
    6.55Total interest income
    
    
    59,112
    
    
    
    
    
    
    
    43,088Interest expense:Repurchase arrangements and similar
borrowings
    
    
    43,185
    
    
    
    2.71
    
    
    
    12,797
    
    
    
    1.16CMOs borrowings
    
    
    546
    
    
    
    3.15
    
    
    
    3,952
    
    
    
    5.93Total interest expense
    
    
    43,731
    
    
    
    
    
    
    
    16,749$
    15,381
    
    
    
    
    
    
    $
    26,339
  Quarter Ended June 30, 2005Rate*
    
    Volume*
    
    TotalInterest income:Mortgage securities and similar investments
    
    $
    2,791
    
    
    $
    8,144
    
    
    $
    10,935CMO collateral
    
    
    (181
    )
    
    
    (1,310
    )
    
    
    (1,491
    )Total interest income
    
    
    2,610
    
    
    
    6,834
    
    
    
    9,444Interest expense:Repurchase arrangements and similar
borrowings
    
    
    12,962
    
    
    
    3,516
    
    
    
    16,478CMOs
    
    
    (264
    )
    
    
    (1,092
    )
    
    
    (1,356
    )Total interest expense
    
    
    12,698
    
    
    
    2,424
    
    
    
    15,122$
    (10,088
    )
    
    $
    4,410
    
    
    $
    (5,678
    )
 -14-




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##### Table of Contents



Six Months Ended June 30, 2005Rate*
    
    Volume*
    
    TotalInterest income:Mortgage securities and similar investments
    
    $
    2,112
    
    
    $
    17,567
    
    
    $
    19,679CMO collateral
    
    
    (1,218
    )
    
    
    (2,437
    )
    
    
    (3,655
    )Total interest income
    
    
    894
    
    
    
    15,130
    
    
    
    16,024Interest expense:Repurchase arrangements and similar
borrowings
    
    
    22,759
    
    
    
    7,629
    
    
    
    30,388CMOs
    
    
    (1,319
    )
    
    
    (2,087
    )
    
    
    (3,406
    )Total interest expense
    
    
    21,440
    
    
    
    5,542
    
    
    
    26,982$
    (20,546
    )
    
    $
    9,588
    
    
    $
    (10,958
    )
 
 *
    
    The change in interest due to both volume and rate has been allocated to
volume and rate changes in proportion to the relationship of the absolute
dollar amounts of the change in each. NOTE 13 3⁄4 SUBSEQUENT EVENT  FORMATION
OF MEZZANINE LOAN JOINT VENTURE
  -15-




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 FINANCIAL CONDITION
 Overview
    Risk Factors and Critical Accounting Policies
 
 -16-




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##### Table of Contents



Book Value per Common Share
   Mortgage Securities and Similar Investments
   -17-




---



##### Table of Contents



2ndQuarter Average(a)
    
    As of June 30, 2005
    
    Projected
    
    LifetimeActual
    
    Actual
    
    Premiums
    
    
    
    
    
    3rdQuarter
    
    RunoffBasis
    
    Yield/Cost
    
    Runoff
    
    (Discounts)
    
    Basis(a)
    
    Yield/Cost(b)
    
    AssumptionsAgency Securities:Fannie Mae/Freddie
Mac:Fixed-rate
    
    $
    29,766
    
    
    
    6.23
    %
    
    
    30
    %
    
    $
    109
    
    
    $
    28,199
    
    
    
    6.34
    %
    
    
    39
    %ARMs
    
    
    2,292,170
    
    
    
    3.47
    
    
    
    33
    
    
    
    44,431
    
    
    
    2,358,183
    
    
    
    3.71
    
    
    
    32Ginnie Mae ARMs
    
    
    987,902
    
    
    
    3.35
    
    
    
    33
    
    
    
    5,879
    
    
    
    951,154
    
    
    
    3.72
    
    
    
    293,309,838
    
    
    
    3.46
    
    
    
    33
    
    
    
    50,419
    
    
    
    3,337,536
    
    
    
    3.73
    
    
    
    31Non-agency Securities:Fixed-rate
    
    
    28,464
    
    
    
    6.38
    
    
    
    28
    
    
    
    7
    
    
    
    27,244
    
    
    
    6.53
    
    
    
    38ARMs
    
    
    50,276
    
    
    
    4.34
    
    
    
    22
    
    
    
    487
    
    
    
    48,846
    
    
    
    4.71
    
    
    
    3778,740
    
    
    
    5.08
    
    
    
    25
    
    
    
    494
    
    
    
    76,090
    
    
    
    5.36
    
    
    
    37CMBS  adjustable-rate
    
    
    50,913
    
    
    
    4.08
    
    
    
    1
    
    
    
    7
    
    
    
    50,841
    
    
    
    4.70
    
    
    
    13,439,491
    
    
    
    3.51
    
    
    
    33
    
    
    $
    50,920
    
    
    
    3,464,467
    
    
    
    3.78
    
    
    
    31Borrowings:30-day LIBOR
    
    
    2,490,356
    
    
    
    3.00
    
    
    
    
    
    
    
    
    
    
    
    2,500,074
    
    
    
    3.48>30-day LIBOR
    
    
    702,241
    
    
    
    2.55
    
    
    
    
    
    
    
    
    
    
    
    706,880
    
    
    
    2.563,192,597
    
    
    
    2.91
    
    
    
    
    
    
    
    
    
    
    
    3,206,954
    
    
    
    3.28Capital employed/
financing spread
    
    $
    246,894
    
    
    
    0.60
    
    
    
    
    
    
    
    
    
    
    $
    257,513
    
    
    
    0.50Return on assets(c)
    
    
    
    
    
    
    0.78
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.67
 
 (a)
    
    Basis represents Capsteads investment before unrealized gains and losses. Actual asset
yields, runoff rates, borrowing rates and resulting financing spread are presented on an
annualized basis.(b)
    
    Projected annualized yields for the third quarter of 2005 reflect ARM coupon resets and
lifetime runoff assumptions as adjusted for expected runoff for this quarter only, as of
July 21, 2005. Actual yields realized in future periods will largely depend upon (i)
changes in portfolio composition, (ii) ARM coupon resets, (iii) actual runoff and (iv) any
changes in lifetime runoff assumptions. Interest rates on borrowings that reset every 30
days at the 30-day London Interbank offered Rate (LIBOR) reflect the estimated effects of
the 25 basis point increase in the federal funds rate on June 30, 2005 and expectations for
25 basis point increases in the federal funds rate at the August 9 and September 20, 2005
Federal Reserve meetings.(c)
    
    The Company uses its liquidity to pay down borrowings. Return on assets is calculated on an
annualized basis assuming the use of this liquidity to reduce borrowing costs (see
Utilization of Capital and Potential Liquidity).  -18-




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##### Table of Contents



CMO Collateral and Investments
  Real Estate Held For Lease
  -19-




---



##### Table of Contents



YearProperty
    
    Location
    
    Units(a)
    
    Occupancy(b)
    
    OpenedChambrel at Roswell
    
    Roswell, GA
    
    280(256 IL; 24 AL
    )
    
    98.6
    %
    
    
    1987Chambrel at Pinecastle
    
    Ocala, FL
    
    161(120 IL; 41 AL
    )
    
    97.5
    
    
    
    1987Chambrel at Island Lake
    
    Longwood, FL
    
    269(229 IL; 40 AL
    )
    
    96.7
    
    
    
    1985Chambrel at Montrose
    
    Akron, OH
    
    169(137 IL; 32 AL
    )
    
    94.1
    
    
    
    1987Chambrel at Williamsburg
    
    Williamsburg, VA
    
    255(200 IL; 55 AL
    )
    
    99.6
    
    
    
    1987Chambrel at Club Hill
    
    Garland, TX
    
    260(192 IL; 68 AL
    )
    
    91.5
    
    
    
    1987Total
    
    
    
    1,394(1,134 IL; 260 AL
    )
    
    96.4
 
 (a)
    
    IL refers to independent living units. AL refers to assisted living units.(b)
    
    As of June 30, 2005.  Utilization of Capital and Potential Liquidity
   -20-




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##### Table of Contents



Capital
    
    PotentialAssets(a)
    
    Borrowings
    
    Employed
    
    Liquidity(a)Mortgage securities and similar
investments:Agency Securities
    
    $
    3,358,722
    
    
    $
    3,098,930
    
    
    $
    259,792
    
    
    $
    157,545Non-agency Securities
    
    
    76,573
    
    
    
    59,914
    
    
    
    16,659
    
    
    
    11,815CMBS
    
    
    50,866
    
    
    
    48,110
    
    
    
    2,756
    
    
    
    (145
    )3,486,161
    
    
    
    3,206,954
    
    
    
    279,207
    
    
    
    169,215CMO collateral
    
    
    22,657
    
    
    
    22,366
    
    
    
    291
    
    
    
    Real estate held for lease (b)
    
    
    139,541
    
    
    
    119,884
    
    
    
    19,657
    
    
    
    $
    3,648,359
    
    
    $
    3,349,204
    
    
    
    299,155
    
    
    
    169,215Other assets, net of other liabilities
    
    
    
    
    
    
    
    
    
    
    31,290
    
    
    
    6,177
    (c)Second quarter common dividend
    
    
    
    
    
    
    
    
    
    
    (1,903
    )
    
    
    (1,903
    )(d)Targeted liquidity reserves for funding
principal payments and margin calls
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (168,055
    )$
    328,542
    
    
    $
    5,434Balances as of December 31, 2004
    
    $
    3,579,480
    
    
    $
    3,341,795
    
    
    $
    332,539
    
    
    $
    9,783
 
 (a)
    
    Assets are stated at carrying amounts on the Companys balance sheet which, particularly
related to real estate held for lease and certain other assets, does not reflect fair
value. Potential liquidity is based on maximum borrowings available under existing
uncommitted repurchase arrangements considering the fair value of related collateral as of
the indicated dates, adjusted separately for targeted liquidity reserves.(b)
    
    Real estate held for lease includes related assets and is net of accumulated depreciation
and other related liabilities.(c)
    
    Represents unrestricted cash and cash equivalents as of June 30, 2005 and $6.0 million of
bankruptcy and special hazard reserve funds expected to be released by the trustee in
August 2005.(d)
    
    The second quarter 2005 common dividend was declared June 16, 2005 and paid July 21, 2005
to stockholders of record as of June 30, 2005. -21-




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##### Table of Contents



RESULTS OF OPERATIONS
  Quarter Ended
    
    Six Months EndedJune 30
    
    June 302005
    
    2004
    
    2005
    
    2004Mortgage securities and similar investments:Agency Securities
    
    $
    6,116
    
    
    $
    11,156
    
    
    $
    13,865
    
    
    $
    22,829Non-agency Securities
    
    
    475
    
    
    
    927
    
    
    
    996
    
    
    
    2,628CMBS
    
    
    144
    
    
    
    180
    
    
    
    280
    
    
    
    362CMO collateral
    
    
    60
    
    
    
    189
    
    
    
    144
    
    
    
    406Net margin on financial assets
    
    
    6,795
    
    
    
    12,452
    
    
    
    15,285
    
    
    
    26,225Real estate held for lease:Lease revenue net of related interest
expense
    
    
    1,389
    
    
    
    1,373
    
    
    
    2,762
    
    
    
    2,813Real estate depreciation
    
    
    (927
    )
    
    
    (927
    )
    
    
    (1,854
    )
    
    
    (1,854
    )Net margin on real estate held for lease
    
    
    462
    
    
    
    446
    
    
    
    908
    
    
    
    959Other revenue (expense):Other revenue
    
    
    215
    
    
    
    249
    
    
    
    411
    
    
    
    316Other operating expense
    
    
    (1,482
    )
    
    
    (1,332
    )
    
    
    (3,012
    )
    
    
    (3,331
    )Total other revenue (expense)
    
    
    (1,267
    )
    
    
    (1,083
    )
    
    
    (2,601
    )
    
    
    (3,015
    )Net income
    
    
    5,990
    
    
    
    11,815
    
    
    
    13,592
    
    
    
    24,169Less cash dividends paid on preferred shares
    
    
    (5,064
    )
    
    
    (5,064
    )
    
    
    (10,128
    )
    
    
    (10,131
    )Net income available to common stockholders
    
    $
    926
    
    
    $
    6,751
    
    
    $
    3,464
    
    
    $
    14,038Operating income *
    
    $
    1,853
    
    
    $
    7,759
    
    
    $
    5,318
    
    
    $
    16,057Weighted average shares outstanding:Basic
    
    
    18,869
    
    
    
    15,237
    
    
    
    18,865
    
    
    
    14,752Diluted and operating
    
    
    18,908
    
    
    
    15,578
    
    
    
    18,905
    
    
    
    15,100Net income per common share:Basic
    
    $
    0.05
    
    
    $
    0.44
    
    
    $
    0.18
    
    
    $
    0.95Diluted
    
    
    0.05
    
    
    
    0.44
    
    
    
    0.18
    
    
    
    0.94Operating *
    
    
    0.10
    
    
    
    0.50
    
    
    
    0.28
    
    
    
    1.06Regular common dividends declared per share
    
    $
    0.10
    
    
    $
    0.50
    
    
    $
    0.28
    
    
    $
    1.03
 
 *
    
    Capstead reports operating income per common share (a non-GAAP financial
measure calculated excluding depreciation on real estate, any gain on asset sales
and the dilutive effects, if present, of the Series B preferred shares) under the
belief it provides investors with a useful supplemental measure of the Companys
operating performance. Operating income represents a measure of the amount of funds
generated by operations, which may, at the discretion of Capsteads Board of
Directors, be used for reinvestment or distributed to common stockholders as
dividends. Depreciation on real estate, although an expense deductible for federal
income tax purposes and therefore an item that reduces Capsteads REIT distribution
requirements, is added back to arrive at operating income because it is a noncash
expense. Gains are excluded because they are considered non-operating in nature and
the amount and timing of any such gains are dependent upon investment strategies and
market conditions. The Series B preferred shares are considered dilutive, for
diluted net income per common share purposes only, whenever annualized basic net
income per common share exceeds $2.13 (the Series B preferred share annualized
dividend of $1.26 divided by the current conversion rate of 0.5903). Operating
income per common share excludes the dilutive effects, if present, of the Series B
preferred shares because it is not economically advantageous to convert these shares
at market prices of both the common shares and Series B preferred shares; therefore
few, if any, Series B preferred share conversions are expected. -22-




---



##### Table of Contents



Quarter Ended
    
    Six Months EndedJune 30
    
    June 302005
    
    2004
    
    2005
    
    2004Agency Securities:Portfolio
    
    $
    3,310
    
    
    $
    2,290
    
    
    $
    3,276
    
    
    $
    2,148Yields
    
    
    3.46
    %
    
    
    3.07
    %
    
    
    3.38
    %
    
    
    3.19
    %Borrowing rates
    
    
    2.89
    
    
    
    1.19
    
    
    
    2.70
    
    
    
    1.13Financing spreads
    
    
    0.57
    
    
    
    1.88
    
    
    
    0.68
    
    
    
    2.06Portfolio runoff rates (annualized)
    
    
    33.14
    
    
    
    29.02
    
    
    
    30.38
    
    
    
    25.34Non-agency Securities:Portfolio
    
    $
    79
    
    
    $
    115
    
    
    $
    82
    
    
    $
    152Yields
    
    
    5.08
    %
    
    
    4.37
    %
    
    
    4.89
    %
    
    
    4.69
    %Borrowing rates
    
    
    3.35
    
    
    
    1.44
    
    
    
    3.12
    
    
    
    1.49Financing spreads
    
    
    1.73
    
    
    
    2.93
    
    
    
    1.77
    
    
    
    3.20Portfolio runoff rates (annualized)
    
    
    24.72
    
    
    
    33.80
    
    
    
    29.10
    
    
    
    39.52CMBS:Portfolio
    
    $
    51
    
    
    $
    73
    
    
    $
    51
    
    
    $
    73Yields
    
    
    4.08
    %
    
    
    2.19
    %
    
    
    3.85
    %
    
    
    2.19
    %Borrowing rates
    
    
    3.13
    
    
    
    1.30
    
    
    
    2.91
    
    
    
    1.29Financing spreads
    
    
    0.95
    
    
    
    0.89
    
    
    
    0.94
    
    
    
    0.90Portfolio runoff rates (annualized)
    
    
    1.28
    
    
    
    0.82
    
    
    
    1.27
    
    
    
    3.31
 -23-




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LIQUIDITY AND CAPITAL RESOURCES
   -24-




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EFFECTS OF INTEREST RATE CHANGES
 Interest Rate Sensitivity on Operating Results
 Other revenue (expense)
 10-year30-day
    
    U.S.LIBOR
    
    TreasuryRate
    
    Rate
    
    Immediate Change In:*30-day LIBOR rate
    
    
    
    
    
    
    
    
    
    Flat
    
    Up 1.00%
    
    Up 1.00
    %
    
    Up 2.00
    %10-year U.S. Treasury rate
    
    
    
    
    
    
    
    
    
    Down 1.00
    %
    
    Flat
    
    Up 1.00
    %
    
    Up 2.00
    %Projected 12-month earnings change:June 30, 2005
    
    
    3.34
    %
    
    
    3.92
    %
    
    $
    (2,419
    )
    
    $
    (15,533
    )
    
    $
    (14,691
    )
    
    $
    (33,647
    )December 31, 2004
    
    
    2.40
    
    
    
    4.22
    
    
    
    (2,297
    )
    
    
    (12,760
    )
    
    
    (11,793
    )
    
    
    (29,259
    )
 
 *
    
    Sensitivity of earnings to changes in interest rates is determined relative to the
actual rates at the applicable date. Note that the projected 12-month earnings change is
predicated on acquisitions of similar assets sufficient to replace runoff. There can be
no guarantee that suitable investments will be available for purchase at attractive
prices or if investments made will behave in the same fashion as assets currently held. -25-




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##### Table of Contents



General Discussion of Effects of Interest Rate Changes
  Average
    
    Average
    
    Average
    
    MonthsCoupon
    
    Periodic
    
    Lifetime
    
    ToARM Type
    
    Basis *
    
    Rate
    
    Cap
    
    Cap
    
    RollAgency
Securities:Fannie Mae/Freddie
Mac:Current-reset
    
    $
    1,787,405
    
    
    
    4.38
    %
    
    
    2.37
    %
    
    
    10.90
    %
    
    
    5.7Longer-to-reset
    
    
    570,778
    
    
    
    4.77
    
    
    
    4.52
    
    
    
    10.71
    
    
    
    24.8Ginnie Mae
    
    
    951,154
    
    
    
    3.98
    
    
    
    1.00
    
    
    
    9.95
    
    
    
    5.1Non-agency Securities
    
    
    48,846
    
    
    
    4.78
    
    
    
    1.73
    
    
    
    11.24
    
    
    
    6.1$
    3,358,183
    
    
    
    4.34
    
    
    
    2.34
    
    
    
    10.60
    
    
    
    8.8
 
 *
    
    Basis represents the Companys investment before unrealized gains and losses.  -26-




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##### Table of Contents



RISKS ASSOCIATED WITH CREDIT-SENSITIVE INVESTMENTS
     -27-




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##### Table of Contents



RISKS ASSOCIATED WITH OWNING REAL ESTATE
  
    
    The risk that changes in economic conditions or real estate markets may adversely affect the value of the properties.
    
    During inflationary periods, which are generally accompanied by rising interest rates, increases in operating costs and
borrowing rates may be greater than increases in lessee revenues from operating properties. Over an extended period of
time, this could result in lessee defaults.
    
    The risk that a deterioration of local conditions could adversely affect the ability of a lessee to profitably operate
a property. For instance, an oversupply of senior living properties could hamper the leasing of senior living units at
favorable rates. This could ultimately affect the value of the properties.
    
    Changes in tax, zoning or other laws could make properties less attractive or less profitable.
 -28-




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##### Table of Contents




    
    An owner cannot be assured that lessees will elect to renew their
leases when the terms expire. If a lessee does not renew its
lease or otherwise defaults on its lease obligations, there is no
assurance the owner can obtain a substitute lessee on acceptable
terms. If the owner cannot obtain another qualified operator to
lease a property, the owner may be required to modify the property
for a different use, which may involve significant capital
expenditures and delays in re-leasing the property.
    
    The risk that lessees will not perform under their leases,
reducing the owners income from the leases or requiring the owner
to assume costs (such as real estate taxes, insurance, utilities
and maintenance) that are the lessees responsibility under
net-leases. In the case of special-purpose real estate such as
senior living facilities, compliance with licensing requirements
could complicate or delay the transfer of operational control of
such properties. This could lead to a significant cash flow
burden for the owner to service the debt and otherwise maintain
the properties.
    
    Net-leases generally require the lessee to carry comprehensive
liability, casualty, workers compensation and rental loss
insurance. The required coverage is typical of the type and
amount customarily obtained by an owner of similar properties.
However, there are some types of losses, such as catastrophic acts
of nature, for which insurance cannot be obtained at a
commercially reasonable cost. If there is an uninsured loss or a
loss in excess of insurance limits, the owner could lose both the
revenues generated by the affected property and the capital
invested in the property. The owner would, however, remain
obligated to repay any mortgage indebtedness or other obligations
related to the property.
    
    Investments in real estate are subject to various federal, state
and local regulatory requirements including the Americans with
Disabilities Act (the ADA). The ADA requires that public
accommodations reasonably accommodate individuals with
disabilities and that new construction or alterations be made to
commercial facilities to conform to accessibility guidelines.
Failure to comply with the ADA can result in injunctions, fines,
damage awards to private parties and additional capital
expenditures to remedy noncompliance. Existing requirements may
change and compliance with future requirements may involve
significant unanticipated expenditures. Typically these
expenditures would be the responsibility of the lessee under the
terms of net-leases; however, if lessees fail to perform these
obligations, the owner may be required to do so.
    
    Under federal, state and local environmental laws, the owner may
be required to investigate and clean up any release of hazardous
or toxic substances or petroleum products at its properties,
regardless of its knowledge or actual responsibility, simply
because of current or past ownership of the real estate. If
unidentified environmental problems arise, the owner may have to
make substantial payments, which could adversely affect cash flow
and the ability to make distributions to stockholders. This is
because:
 1.
    
    The owner may have to pay for property damage and for investigation and clean-up
costs incurred in connection with the contamination.2.
    
    The law may impose clean-up responsibility and liability regardless of whether the
owner or operator knew of or caused the contamination. Even if more than one person is
responsible for the contamination, each person who shares legal liability under
environmental laws may be held responsible for all of the clean-up costs.3.
    
    Governmental entities and third parties may sue the owner or operator of a
contaminated site for damages and costs.
 
    
    In investigating the acquisition of real estate, environmental studies are typically
performed to establish the existence of any contamination. In addition, net-leases generally
require lessees to operate properties in compliance with environmental laws and to indemnify
the owner against environmental liability arising from the operation of such properties.
 -29-




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##### Table of Contents




    
    An owner may desire to sell a property in the future because of
changes in market conditions or poor lessee performance or to
avail itself of other opportunities. An owner may also be
required to sell a property to meet debt obligations or avoid a
default. Unlike investments in mortgage securities, real estate
cannot always be sold quickly, and there can be no assurance that
a property can be sold at a favorable price or that a prospective
buyer will view existing lease or operating arrangements
favorably. In addition, a property may require restoration or
modification before it is sold.
 REGULATORY MATTERS
 Tax Status
    Investment Company Act of 1940
   -30-




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##### Table of Contents



CRITICAL ACCOUNTING POLICIES
   
    
    Amortization of Premiums and Discounts on Financial Assets and
Borrowings Premiums and discounts on financial assets and
borrowings are recognized in earnings as adjustments to interest
income or interest expense by the interest method over the
estimated lives of the related assets or borrowings. For most of
Capsteads financial assets, estimates and judgments related to
future levels of mortgage prepayments are critical to this
determination. Mortgage prepayment expectations can vary
considerably from period to period based on current and projected
changes in interest rates and other factors such as portfolio
composition.
    
    Fair Value and Impairment Accounting for Financial Assets Most
of Capsteads financial assets are classified as held
available-for-sale and recorded at fair value on the balance sheet
with unrealized gains and losses recorded in stockholders equity
as a component of Accumulated other comprehensive income. As
such, these unrealized gains and losses enter into the calculation
of book value per common share. Fair values fluctuate with
current and projected changes in interest rates, prepayment
expectations and other factors, such as market liquidity.
Considerable judgment is required interpreting market data to
develop estimated fair values, particularly in circumstances of
deteriorating credit quality and market liquidity (see NOTE 10
to the accompanying consolidated financial statements for
discussion of how Capstead values its financial assets).
Generally, gains or losses are recognized in earnings only if
sold; however, if a decline in fair value of an individual asset
below its amortized cost occurs that is determined to be other
than temporary, the difference between amortized cost and fair
value would be included in Other revenue (expense)as an
impairment charge.
    
    Depreciation and Impairment Accounting for Real Estate held for
Lease Real estate is carried at cost, less accumulated
depreciation. Depreciation is provided using the straight-line
method over the estimated useful lives of buildings, equipment and
fixtures. If a significant adverse event or change in
circumstances occurs, management would assess if the values of the
Companys real estate properties have become impaired. If
estimated operating cash flows (undiscounted and without interest
charges) of a property over its remaining useful life are less
than its net carrying value, the difference between net carrying
value and fair value would be included in Other revenue (expense)
as an impairment charge. Considerable judgment is required in
determining useful lives of components of real estate properties
and in estimating operating cash flows, particularly during
periods of changing circumstances.
 -31-




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##### Table of Contents



FORWARD LOOKING STATEMENTS
  COMPARISON OF OPERATING INCOME AND DILUTED INCOME PER SHARE
  Quarter EndedJune 30, 2005
    
    June 30, 2004Operating
    
    Diluted
    
    Operating
    
    DilutedNet income
    
    $
    5,990
    
    
    $
    5,990
    
    
    $
    11,815
    
    
    $
    11,815Adjustments for:Depreciation on real estate
    
    
    927
    
    
    
    
    
    
    
    927
    
    
    
    Dividends on antidilutive
preferred shares
    
    
    (5,064
    )
    
    
    (5,064
    )
    
    
    (4,983
    )
    
    
    (4,983
    )$
    1,853
    
    
    $
    926
    
    
    $
    7,759
    
    
    $
    6,832Weighted average common
shares outstanding
    
    
    18,869
    
    
    
    18,869
    
    
    
    15,237
    
    
    
    15,237Net effect of dilutive securities:Stock options
    
    
    39
    
    
    
    39
    
    
    
    30
    
    
    
    30Preferred A shares
    
    
    
    
    
    
    
    
    
    
    311
    
    
    
    31118,908
    
    
    
    18,908
    
    
    
    15,578
    
    
    
    15,578Per common share
    
    $
    0.10
    
    
    $
    0.05
    
    
    $
    0.50
    
    
    $
    0.44
 -32-




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##### Table of Contents



Six Months EndedJune 30, 2005
    
    June 30, 2004Operating
    
    Diluted
    
    Operating
    
    DilutedNet income
    
    $
    13,592
    
    
    $
    13,592
    
    
    $
    24,169
    
    
    $
    24,169Adjustments for:Depreciation on real estate
    
    
    1,854
    
    
    
    
    
    
    
    1,854
    
    
    
    Dividends on antidilutive
preferred shares
    
    
    (10,128
    )
    
    
    (10,128
    )
    
    
    (9,966
    )
    
    
    (9,966
    )$
    5,318
    
    
    $
    3,464
    
    
    $
    16,057
    
    
    $
    14,203Weighted average common
shares outstanding
    
    
    18,865
    
    
    
    18,865
    
    
    
    14,752
    
    
    
    14,752Net effect of dilutive securities:Stock options
    
    
    40
    
    
    
    40
    
    
    
    35
    
    
    
    35Preferred A shares
    
    
    
    
    
    
    
    
    
    
    313
    
    
    
    31318,905
    
    
    
    18,905
    
    
    
    15,100
    
    
    
    15,100Per common share
    
    $
    0.28
    
    
    $
    0.18
    
    
    $
    1.06
    
    
    $
    0.94
 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS
  
 ITEM 4. CONTROLS AND PROCEDURES
  
 PART II. 3⁄4 OTHER INFORMATION
 
 ITEM 5. OTHER INFORMATION
 Formation of Mezzanine Joint Venture
  -33-




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##### Table of Contents



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 (a)
    
    Exhibits: The following Exhibits are presented herewith:Exhibit 10.1  Form of master agreement dated as of May 10, 2005 between Crescent Real Estate
Capital, L.P. and CMC Real Estate Capital L.P., including a form of limited partnership
agreement between Crescent Redtail Management LLC, Crescent Real Estate Capital L.P. and CMC
Real Estate Capital L.P.Exhibit 10.2  Forms of nonqualified stock option and restricted stock agreements for
non-employee directors.Exhibit 10.3  Forms of nonqualified stock option and restricted stock agreements for
employees.Exhibit 10.4  2005 nonqualified stock option and restricted stock agreements for non-employee
directors and named executives.Exhibit 12  Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock
Dividends.Exhibit 31.1  Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002Exhibit 31.2  Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002Exhibit 32  Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(b)
    
    Reports on Form 8-K:Current Report on Form 8-K dated April 21, 2005 furnishing the press release announcing first
quarter 2005 financial results.Current Report of Form 8-K dated May 10, 2005 announcing Capstead entered into a master
agreement with CEI to co-invest in mezzanine loan opportunities.Current Report on Form 8-K dated May 10, 2005 furnishing the press release announcing the
execution of the above-mentioned master agreement with CEI.Current Report on Form 8-K dated May 13, 2005 announcing the issuance of grants of options and
restricted stock to the Companys directors and employees.
 -34-




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Current Report on Form 8-K dated June 16, 2005 announcing the election of two new members of
the Board of Directors and related compensation matters.Current Report on Form 8-K dated June 16, 2005 furnishing the press release announcing second
quarter 2005 common dividend.Current Report on Form 8-K dated July 21, 2005 furnishing the press release announcing second
quarter 2005 financial results.
 
 SIGNATURES
  CAPSTEAD MORTGAGE CORPORATIONRegistrantDate: July 29, 2005
    
    By:
    
    /s/ ANDREW F. JACOBSAndrew F. JacobsPresident and Chief Executive OfficerDate: July 29, 2005
    
    By:
    
    /s/ PHILLIP A. REINSCHPhillip A. ReinschSenior Vice President andChief Financial Officer
 -35-