##### 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: September 30, 2006
 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
    
    75-2027937(State or other jurisdiction of 
incorporation or organization)
    
    (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
  o þ o
 o þ
 APPLICABLE ONLY TO CORPORATE ISSUERS:
  Common Stock ($0.01 par value)
    
    19,043,302 as of November 6, 2006




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##### 



CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2006
 INDEX
 PagePART I. 3⁄4 FINANCIAL INFORMATIONITEM 1. Financial StatementsConsolidated Balance Sheets 3⁄4 September 30, 2006 and December 31, 2005
    
    
    3Consolidated Statements of Operations 3⁄4 Quarter and Nine Months Ended
September 30, 2006 and 2005
    
    
    4Consolidated Statements of Cash Flows 3⁄4 Nine Months Ended September 30, 2006 and 2005
    
    
    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
    
    
    32ITEM 4. Controls and Procedures
    
    
    32PART II. 3⁄4 OTHER INFORMATIONITEM 6. Exhibits and Reports on Form 8-K
    
    
    32SIGNATURES
    
    
    33Computation of Ratio of EarningsCertification Pusuant to Section 302(a)Certification Pusuant to Section 302(a)Certification Pursuant to Section 906
  -2-




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##### Table of Contents



ITEM 1. FINANCIAL STATEMENTS
 
 PART I. 3⁄4 FINANCIAL INFORMATION
 CAPSTEAD MORTGAGE CORPORATION
 
 CONSOLIDATED BALANCE SHEETS
 (in thousands, except per share amounts)
 September 30, 2006
    
    
    December 31, 2005(unaudited)
    
    
    (NOTE 2)Assets:Mortgage securities and similar investments
($5.0 billion pledged under repurchase arrangements)
    
    $
    5,190,790
    
    
    $
    4,368,025Investments in unconsolidated affiliates
    
    
    20,098
    
    
    
    9,246Receivables and other assets
    
    
    68,844
    
    
    
    53,040Cash and cash equivalents
    
    
    4,195
    
    
    
    33,937$
    5,283,927
    
    
    $
    4,464,248Liabilities:Repurchase arrangements and similar borrowings
    
    $
    4,827,842
    
    
    $
    4,023,686Unsecured borrowings
    
    
    103,095
    
    
    
    77,321Liabilities of discontinued operation
    
    
    
    
    
    
    2,884Common stock dividend payable
    
    
    381
    
    
    
    381Accounts payable and accrued expenses
    
    
    13,948
    
    
    
    15,1274,945,266
    
    
    
    4,119,399Stockholders equity:Preferred stock  $0.10 par value; 100,000 shares authorized:$1.60 Cumulative Preferred Stock, Series A,
202 shares issued and outstanding at
September 30, 2006 and December 31, 2005
($3,317 aggregate liquidation preference)
    
    
    2,828
    
    
    
    2,828$1.26 Cumulative Convertible Preferred Stock, Series B,
15,819 shares issued and outstanding at
September 30, 2006 and December 31, 2005
($180,025 aggregate liquidation preference)
    
    
    176,705
    
    
    
    176,705Common stock  $0.01 par value; 100,000 shares authorized:19,043 shares issued and outstanding at
September 30, 2006 and December 31, 2005
    
    
    190
    
    
    
    190Paid-in capital
    
    
    500,287
    
    
    
    512,933Accumulated deficit
    
    
    (354,617
    )
    
    
    (352,803
    )Accumulated other comprehensive income
    
    
    13,268
    
    
    
    4,996338,661
    
    
    
    344,849$
    5,283,927
    
    
    $
    4,464,248
 See accompanying notes to consolidated financial statements.
 -3-




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##### Table of Contents



CAPSTEAD MORTGAGE CORPORATION
 
 CONSOLIDATED STATEMENTS OF INCOME
 (in thousands, except per share amounts)
 (unaudited)
 Quarter Ended
    
    
    Nine Months EndedSeptember 30
    
    
    September 302006
    
    
    2005
    
    
    2006
    
    
    2005Mortgage securities and similar investments:Interest income
    
    $
    62,230
    
    
    $
    32,826
    
    
    $
    172,505
    
    
    $
    91,938Interest expense
    
    
    (61,066
    )
    
    
    (27,542
    )
    
    
    (163,294
    )
    
    
    (71,369
    )1,164
    
    
    
    5,284
    
    
    
    9,211
    
    
    
    20,569Other revenue (expense):Other revenue
    
    
    63
    
    
    
    477
    
    
    
    429
    
    
    
    888Interest expense on unsecured borrowings
    
    
    (1,747
    )
    
    
    (41
    )
    
    
    (4,955
    )
    
    
    (41
    )Other operating expense
    
    
    (1,627
    )
    
    
    (1,531
    )
    
    
    (4,876
    )
    
    
    (4,543
    )(3,311
    )
    
    
    (1,095
    )
    
    
    (9,402
    )
    
    
    (3,696
    )Income (loss) before equity in earnings (losses) of
unconsolidated affiliates and discontinued
operation
    
    
    (2,147
    )
    
    
    4,189
    
    
    
    (191
    )
    
    
    16,873Equity in earnings (losses) of unconsolidated
affiliates
    
    
    654
    
    
    
    (42
    )
    
    
    1,684
    
    
    
    (42
    )Income (loss) from continuing operations
    
    
    (1,493
    )
    
    
    4,147
    
    
    
    1,493
    
    
    
    16,831Income from discontinued operation
    
    
    
    
    
    
    468
    
    
    
    
    
    
    
    1,376Net income (loss)
    
    $
    (1,493
    )
    
    $
    4,615
    
    
    $
    1,493
    
    
    $
    18,207Net income available (loss attributable) to
common stockholders:Net income (loss)
    
    $
    (1,493
    )
    
    $
    4,615
    
    
    $
    1,493
    
    
    $
    18,207Less cash dividends paid on preferred stock
    
    
    (5,064
    )
    
    
    (5,064
    )
    
    
    (15,192
    )
    
    
    (15,192
    )$
    (6,557
    )
    
    $
    (449
    )
    
    $
    (13,699
    )
    
    $
    3,015Basic and diluted earnings (loss) per common share:Income (loss) from continuing operations
    
    $
    (0.35
    )
    
    $
    (0.05
    )
    
    $
    (0.73
    )
    
    $
    0.09Income from discontinued operation
    
    
    
    
    
    
    0.03
    
    
    
    
    
    
    
    0.07$
    (0.35
    )
    
    $
    (0.02
    )
    
    $
    (0.73
    )
    
    $
    0.16Cash dividends declared per share:Common
    
    $
    0.020
    
    
    $
    0.020
    
    
    $
    0.060
    
    
    $
    0.300Series A Preferred
    
    
    0.400
    
    
    
    0.400
    
    
    
    1.200
    
    
    
    1.200Series B Preferred
    
    
    0.315
    
    
    
    0.315
    
    
    
    0.945
    
    
    
    0.945
 See accompanying notes to consolidated financial statements.
 -4-




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CAPSTEAD MORTGAGE CORPORATION
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 (unaudited)
 Nine Months Ended September 302006
    
    
    2005Operating activities:Net income
    
    $
    1,493
    
    
    $
    18,207Noncash items:Amortization of investment premiums
    
    
    17,620
    
    
    
    15,864Depreciation and other amortization
    
    
    76
    
    
    
    114Stock-based compensation
    
    
    392
    
    
    
    139Undistributed earnings of unconsolidated affiliates
    
    
    (141
    )
    
    
    42Gain on structured financing redemption
    
    
    
    
    
    
    (156
    )Net change in receivables, other assets, accounts payable and
accrued expenses
    
    
    (8,768
    )
    
    
    (10,817
    )Net cash provided by operating activities of continuing operations
    
    
    10,672
    
    
    
    23,393Net cash provided by operating activities of discontinued operation
    
    
    
    
    
    
    2,051Net cash provided by operating activities
    
    
    10,672
    
    
    
    25,444Investing activities:Purchases of mortgage securities and similar investments
    
    
    (2,130,829
    )
    
    
    (1,291,614
    )Principal collections on mortgage securities and similar investments
    
    
    1,291,089
    
    
    
    1,032,393Investments in unconsolidated affiliates:Investment in statutory trusts formed to issue other borrowings
    
    
    (774
    )
    
    
    (1,083
    )Investment in commercial real estate loan limited partnership
    
    
    (12,749
    )
    
    
    (3,460
    )Return of investment in commercial real estate loan limited
partnership
    
    
    2,812
    
    
    
    Net cash used in investing activities of continuing operations
    
    
    (850,451
    )
    
    
    (263,764
    )Net cash used in investing activities of discontinued operation
    
    
    (2,884
    )
    
    
    Net cash used in investing activities
    
    
    (853,335
    )
    
    
    (263,764
    )Financing activities:Net increase in repurchase arrangements and similar borrowings
    
    
    804,178
    
    
    
    153,494Unsecured borrowings, net of issue costs
    
    
    25,086
    
    
    
    34,925Release of restricted cash
    
    
    
    
    
    
    5,996Capital stock transactions
    
    
    (9
    )
    
    
    26Dividends paid
    
    
    (16,334
    )
    
    
    (24,645
    )Net cash provided by financing activities of continuing operations
    
    
    812,921
    
    
    
    169,796Net cash used in financing activities of discontinued operation
    
    
    
    
    
    
    (172
    )Net cash provided by financing activities
    
    
    812,921
    
    
    
    169,624Net change in cash and cash equivalents
    
    
    (29,742
    )
    
    
    (68,696
    )Cash and cash equivalents at beginning of period
    
    
    33,937
    
    
    
    73,030Cash and cash equivalents at end of period
    
    $
    4,195
    
    
    $
    4,334
 See accompanying notes to consolidated financial statements.
 -5-




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CAPSTEAD MORTGAGE CORPORATION
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER 30, 2006
 (unaudited)
 NOTE 1 3⁄4 BUSINESS
  NOTE 2 3⁄4 BASIS OF PRESENTATION
 Interim Financial Reporting
  Reclassifications
 Mortgage
securities and similar investments
 Stock-Based Compensation
  -6-




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##### Table of Contents



Other operating expense
 Accounting for Acquisitions of Mortgage Securities Seller-Financed using Repurchase Arrangements
 Other comprehensive income (loss)
   NOTE 3 3⁄4 EARNINGS (LOSS) PER COMMON SHARE
 Income (loss) from continuing operations Income from discontinued operation
 -7-




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##### Table of Contents



Quarter Ended
    
    
    Nine Months EndedSeptember 30
    
    
    September 302006
    
    
    2005
    
    
    2006
    
    
    2005Numerators for basic earnings (loss)
per common share:Income (loss) from continuing operations
    
    $
    (1,493
    )
    
    $
    4,147
    
    
    $
    1,493
    
    
    $
    16,831Less Series A and B preferred share dividends
    
    
    (5,064
    )
    
    
    (5,064
    )
    
    
    (15,192
    )
    
    
    (15,192
    )Income from continuing operations available
(loss attributable) to common stockholders
    
    
    (6,557
    )
    
    
    (917
    )
    
    
    (13,699
    )
    
    
    1,639Income from discontinued operation
    
    
    
    
    
    
    468
    
    
    
    
    
    
    
    1,376$
    (6,557
    )
    
    $
    (449
    )
    
    $
    (13,699
    )
    
    $
    3,015Weighted average common shares outstanding
    
    
    18,918
    
    
    
    18,871
    
    
    
    18,895
    
    
    
    18,867Basic earnings (loss) per common share:Income (loss) from continuing operations
    
    $
    (0.35
    )
    
    $
    (0.05
    )
    
    $
    (0.73
    )
    
    $
    0.09Income from discontinued operation
    
    
    
    
    
    
    0.03
    
    
    
    
    
    
    
    0.07$
    (0.35
    )
    
    $
    (0.02
    )
    
    $
    (0.73
    )
    
    $
    0.16Numerators for diluted earnings (loss)
per common share:Income (loss) from continuing operations
    
    $
    (1,493
    )
    
    $
    4,147
    
    
    $
    1,493
    
    
    $
    16,831Less dividends on antidilutive convertible
preferred shares
    
    
    (5,064
    )
    
    
    (5,064
    )
    
    
    (15,192
    )
    
    
    (15,192
    )Income from continuing operations available
(loss attributable) to common stockholders
    
    
    (6,557
    )
    
    
    (917
    )
    
    
    (13,699
    )
    
    
    1,639Income from discontinued operation
    
    
    
    
    
    
    428
    
    
    
    
    
    
    
    1,376$
    (6,557
    )
    
    $
    (449
    )
    
    $
    (13,699
    )
    
    $
    3,015Denominator for diluted earnings (loss)
per common share:Weighted average common shares outstanding
    
    
    18,918
    
    
    
    18,871
    
    
    
    18,895
    
    
    
    18,867Net effect of dilutive stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    48Net effect of dilutive convertible preferred shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,918
    
    
    
    18,871
    
    
    
    18,895
    
    
    
    18,915Diluted earnings (loss) per common share:Income (loss) from continuing operations
    
    $
    (0.35
    )
    
    $
    (0.05
    )
    
    $
    (0.73
    )
    
    $
    0.09Income from discontinued operation
    
    
    
    
    
    
    0.03
    
    
    
    
    
    
    
    0.07$
    (0.35
    )
    
    $
    (0.02
    )
    
    $
    (0.73
    )
    
    $
    0.16Antidilutive securities excluded from the calculation
of diluted earnings (loss) per common share:Nonvested stock grants and shares issuable
under stock option awards
    
    
    999
    
    
    
    341
    
    
    
    999
    
    
    
    338Series A preferred shares
    
    
    202
    
    
    
    202
    
    
    
    202
    
    
    
    202Series B preferred shares
    
    
    15,819
    
    
    
    15,819
    
    
    
    15,819
    
    
    
    15,819
 NOTE 4 3⁄4 MORTGAGE SECURITIES AND SIMILAR INVESTMENTS
  -8-




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##### Table of Contents



Mortgage securities and similar investments
 Principal
    
    
    
    
    
    
    
    
    
    
    Carrying
    
    
    Net
    
    
    AverageBalance
    
    
    Premiums
    
    
    Basis
    
    
    Amount(a)
    
    
    WAC(b)
    
    
    Yield(b)September 30, 2006Agency Securities:Fannie Mae/Freddie Mac:Fixed-rate
    
    $
    18,479
    
    
    $
    61
    
    
    $
    18,540
    
    
    $
    18,571
    
    
    
    6.63
    %
    
    
    6.32
    %ARMs
    
    
    4,215,830
    
    
    
    59,219
    
    
    
    4,275,049
    
    
    
    4,285,290
    
    
    
    5.94
    
    
    
    5.04Ginnie Mae ARMs
    
    
    819,167
    
    
    
    2,616
    
    
    
    821,783
    
    
    
    824,264
    
    
    
    4.98
    
    
    
    4.905,053,476
    
    
    
    61,896
    
    
    
    5,115,372
    
    
    
    5,128,125
    
    
    
    5.79
    
    
    
    5.02Non-agency Securities:Fixed-rate
    
    
    19,064
    
    
    
    49
    
    
    
    19,113
    
    
    
    19,146
    
    
    
    7.15
    
    
    
    6.43ARMs
    
    
    33,999
    
    
    
    327
    
    
    
    34,326
    
    
    
    34,637
    
    
    
    6.77
    
    
    
    6.2953,063
    
    
    
    376
    
    
    
    53,439
    
    
    
    53,783
    
    
    
    6.91
    
    
    
    6.34Commercial loans
    
    
    2,520
    
    
    
    
    
    
    
    2,520
    
    
    
    2,520
    
    
    
    18.00
    
    
    
    18.00Collateral for structured
financings
    
    
    6,264
    
    
    
    98
    
    
    
    6,362
    
    
    
    6,362
    
    
    
    8.02
    
    
    
    7.75$
    5,115,323
    
    
    $
    62,370
    
    
    $
    5,177,693
    
    
    $
    5,190,790
    
    
    
    5.81
    
    
    
    5.04December 31, 2005Agency Securities:Fannie Mae/Freddie Mac:Fixed-rate
    
    $
    23,547
    
    
    $
    87
    
    
    $
    23,634
    
    
    $
    23,670
    
    
    
    6.63
    %
    
    
    6.29
    %ARMs
    
    
    3,268,374
    
    
    
    54,792
    
    
    
    3,323,166
    
    
    
    3,324,118
    
    
    
    5.13
    
    
    
    3.99Ginnie Mae ARMs
    
    
    933,897
    
    
    
    4,222
    
    
    
    938,119
    
    
    
    941,542
    
    
    
    4.46
    
    
    
    4.074,225,818
    
    
    
    59,101
    
    
    
    4,284,919
    
    
    
    4,289,330
    
    
    
    4.99
    
    
    
    4.03Non-agency Securities:Fixed-rate
    
    
    26,493
    
    
    
    114
    
    
    
    26,607
    
    
    
    26,689
    
    
    
    7.12
    
    
    
    6.76ARMs
    
    
    42,150
    
    
    
    467
    
    
    
    42,617
    
    
    
    42,908
    
    
    
    5.33
    
    
    
    4.7268,643
    
    
    
    581
    
    
    
    69,224
    
    
    
    69,597
    
    
    
    6.02
    
    
    
    5.47CMBS
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4.99Collateral for structured
financings
    
    
    8,960
    
    
    
    138
    
    
    
    9,098
    
    
    
    9,098
    
    
    
    7.80
    
    
    
    7.49$
    4,303,421
    
    
    $
    59,820
    
    
    $
    4,363,241
    
    
    $
    4,368,025
    
    
    
    5.01
    
    
    
    4.07
 
 (a)
    
    Includes mark-to-market for securities classified as available-for-sale, if applicable
(see NOTE 9).(b)
    
    Net WAC, or net weighted average coupon rate, is presented net of servicing and other fees
as of the indicated balance sheet date. Average Yield is presented for the quarter then
ended, calculated including the amortization of investment premiums, mortgage insurance costs
on Non-agency Securities and excluding unrealized gains and losses. -9-




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##### Table of Contents



NOTE 5 3⁄4 INVESTMENTS IN UNCONSOLIDATED AFFILIATES
    NOTE 6 3⁄4 SALE OF DISCONTINUED OPERATION REAL ESTATE HELD FOR LEASE)
  NOTE 7 3⁄4 REPURCHASE ARRANGEMENTS AND SIMILAR BORROWINGS
  -10-




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##### Table of Contents



September 30, 2006
    
    
    December 31, 2005Borrowings
    
    
    Average
    
    
    Borrowings
    
    
    AverageOutstanding
    
    
    Rate
    
    
    Outstanding
    
    
    RateBorrowings with maturities of 30 days or less:Agency Securities
    
    $
    1,500,769
    
    
    
    5.27
    %
    
    $
    3,133,090
    
    
    
    4.23
    %Non-agency Securities
    
    
    48,987
    
    
    
    5.83
    
    
    
    63,734
    
    
    
    4.881,549,756
    
    
    
    5.29
    
    
    
    3,196,824
    
    
    
    4.24Borrowings with maturities greater than 30 days:Agency Securities (31 to 90 days)*
    
    
    2,129,980
    
    
    
    5.29
    
    
    
    25,000
    
    
    
    3.25Agency Securities (91 to 360 days)
    
    
    210,071
    
    
    
    4.17
    
    
    
    331,907
    
    
    
    2.79Agency Securities (greater than 360 days)
    
    
    931,673
    
    
    
    4.99
    
    
    
    460,857
    
    
    
    4.503,271,724
    
    
    
    5.18
    
    
    
    817,764
    
    
    
    3.77Collateral for structured financings
    
    
    6,362
    
    
    
    7.75
    
    
    
    9,098
    
    
    
    7.95$
    4,827,842
    
    
    
    5.19
    
    
    $
    4,023,686
    
    
    
    4.15
 
 *
    
    Maturities range from 31 to 43 days as of September 30, 2006. Repurchase arrangements and similar borrowings
 NOTE 8 3⁄4 UNSECURED BORROWINGS
 Unsecured borrowings
 September 30, 2006
    
    
    December 31, 2005Borrowings
    
    
    Average
    
    
    Borrowings
    
    
    AverageOutstanding
    
    
    Rate
    
    
    Outstanding
    
    
    RateJunior subordinated notes:Capstead Mortgage Trust I
    
    $
    36,083
    
    
    
    8.31
    %
    
    $
    36,083
    
    
    
    8.31
    %Capstead Mortgage Trust II
    
    
    41,238
    
    
    
    8.46
    
    
    
    41,238
    
    
    
    8.45Capstead Mortgage Trust III
    
    
    25,774
    
    
    
    8.78
    
    
    
    
    
    
    
    $
    103,095
    
    
    
    8.49
    
    
    $
    77,321
    
    
    
    8.39
  -11-




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##### Table of Contents



Receivables and other assets Unsecured borrowings
 NOTE 9 3⁄4 DISCLOSURES REGARDING FAIR VALUES OF FINANCIAL INSTRUMENTS
  September 30, 2006
    
    
    December 31, 2005Fair
    
    
    Unrealized
    
    
    Fair
    
    
    UnrealizedValue
    
    
    Loss
    
    
    Value
    
    
    LossSecurities in an unrealized loss position:One year or greater
    
    $
    867,884
    
    
    $
    8,497
    
    
    $
    472,584
    
    
    $
    6,313Less than one year
    
    
    236,742
    
    
    
    712
    
    
    
    1,431,465
    
    
    
    8,611$
    1,104,626
    
    
    $
    9,209
    
    
    $
    1,904,049
    
    
    $
    14,924
  Gross
    
    
    GrossUnrealized
    
    
    Unrealized
    
    
    FairBasis
    
    
    Gains
    
    
    Losses
    
    
    ValueAs of September 30, 2006Agency Securities:Fixed-rate
    
    $
    375
    
    
    $
    31
    
    
    $
    
    
    
    $
    406ARMs
    
    
    5,096,832
    
    
    
    21,903
    
    
    
    9,183
    
    
    
    5,109,5525,097,207
    
    
    
    21,934
    
    
    
    9,183
    
    
    
    5,109,958Non-agency Securities
    
    
    27,053
    
    
    
    352
    
    
    
    6
    
    
    
    27,399$
    5,124,260
    
    
    $
    22,286
    
    
    $
    9,189
    
    
    $
    5,137,357As of December 31, 2005Agency Securities:Fixed-rate
    
    $
    440
    
    
    $
    36
    
    
    $
    
    
    
    $
    476ARMs
    
    
    4,261,285
    
    
    
    19,273
    
    
    
    14,898
    
    
    
    4,265,6604,261,725
    
    
    
    19,309
    
    
    
    14,898
    
    
    
    4,266,136Non-agency Securities
    
    
    33,987
    
    
    
    390
    
    
    
    17
    
    
    
    34,360$
    4,295,712
    
    
    $
    19,699
    
    
    $
    14,915
    
    
    $
    4,300,496
 -12-




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##### Table of Contents



Gross
    
    
    GrossUnrealized
    
    
    Unrealized
    
    
    FairBasis
    
    
    Gains
    
    
    Losses
    
    
    ValueAs of September 30, 2006Collateral released from structured
financings:Agency Securities
    
    $
    18,165
    
    
    $
    327
    
    
    $
    1
    
    
    $
    18,491Non-agency Securities
    
    
    26,386
    
    
    
    368
    
    
    
    19
    
    
    
    26,735Collateral for structured financings
    
    
    6,362
    
    
    
    
    
    
    
    
    
    
    
    6,362$
    50,913
    
    
    $
    695
    
    
    $
    20
    
    
    $
    51,588As of December 31, 2005Collateral released from structured
financings:Agency Securities
    
    $
    23,194
    
    
    $
    636
    
    
    $
    
    
    
    $
    23,830Non-agency Securities
    
    
    35,237
    
    
    
    590
    
    
    
    9
    
    
    
    35,818Collateral for structured financings
    
    
    9,098
    
    
    
    
    
    
    
    
    
    
    
    9,098$
    67,529
    
    
    $
    1,226
    
    
    $
    9
    
    
    $
    68,746
 NOTE 10 3⁄4 COMPREHENSIVE INCOME (LOSS)
  Quarter Ended
    
    
    Nine Months EndedSeptember 30
    
    
    September 302006
    
    
    2005
    
    
    2006
    
    
    2005Net income (loss)
    
    $
    (1,493
    )
    
    $
    4,615
    
    
    $
    1,493
    
    
    $
    18,207Other comprehensive income (loss):Amounts related to cash flow hedges:Reclassification adjustment for amounts
included in net income
    
    
    (11
    )
    
    
    (39
    )
    
    
    (41
    )
    
    
    (90
    )Amounts related to discontinued operation
    
    
    
    
    
    
    12
    
    
    
    
    
    
    
    4Amounts related to securities held
available-for-sale:Change in valuation of mortgage securities
held available-for-sale
    
    
    24,287
    
    
    
    (10,025
    )
    
    
    8,313
    
    
    
    (12,230
    )Other comprehensive income (loss)
    
    
    24,276
    
    
    
    (10,052
    )
    
    
    8,272
    
    
    
    (12,316
    )Comprehensive income (loss)
    
    $
    22,783
    
    
    $
    (5,437
    )
    
    $
    9,765
    
    
    $
    5,891
 NOTE 11 3⁄4 LONG-TERM INCENTIVE AND OTHER PLANS
  -13-




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##### Table of Contents



Nonvested Stock Grant Activity
 Weighted AverageNumber of
    
    
    Grant DateShares
    
    
    Fair ValueAs of December 31, 2005
    
    
    172,600
    
    
    $
    7.86Grants
    
    
    21,457
    
    
    
    6.86Forfeitures
    
    
    (20,800
    )
    
    
    7.82Vested
    
    
    (49,207
    )
    
    
    7.75As of September 30, 2006
    
    
    124,050
    
    
    
    7.74
  Stock Option Grant Activity
 Number
    
    
    Weightedof
    
    
    AverageShares
    
    
    Exercise PriceAs of December 31, 2005 (419,782
exercisable at average price: $21.87)
    
    
    777,669
    
    
    $
    15.33Grants (average fair value: $0.78)*
    
    
    258,000
    
    
    
    7.43Forfeitures
    
    
    (84,625
    )
    
    
    7.74Expirations
    
    
    (76,348
    )
    
    
    22.86Exercises
    
    
    
    
    
    
    As of September 30, 2006 (465,071
exercisable at average price: $17.89)
    
    
    874,696
    
    
    $
    13.08
 
 *
    
    Option grants were valued with average expected terms of four years, volatility
factors of 31%, dividend yields of 10% and risk-free rates of 4.91%.   -14-




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##### Table of Contents



NOTE 12 3⁄4 NET INTEREST INCOME ANALYSIS
 Unsecured
borrowings
 Quarter Ended September 302006
    
    
    2005Average
    
    
    
    
    
    
    AverageAmount
    
    
    Rate
    
    
    Amount
    
    
    RateInterest income
    
    $
    62,230
    
    
    
    5.04
    %
    
    $
    32,826
    
    
    
    3.75
    %Interest expense
    
    
    (61,066
    )
    
    
    5.20
    
    
    
    (27,542
    )
    
    
    3.31$
    1,164
    
    
    
    (0.16
    )
    
    $
    5,284
    
    
    
    0.44
 Nine Months Ended September 302006
    
    
    2005Average
    
    
    
    
    
    
    AverageAmount
    
    
    Rate
    
    
    Amount
    
    
    RateInterest income
    
    $
    172,505
    
    
    
    4.78
    %
    
    $
    91,938
    
    
    
    3.54
    %Interest expense
    
    
    (163,294
    )
    
    
    4.81
    
    
    
    (71,369
    )
    
    
    2.92$
    9,211
    
    
    
    (0.03
    )
    
    $
    20,569
    
    
    
    0.62
  Quarter Ended September 30, 2006Rate *
    
    
    Volume *
    
    
    Total *Total interest income
    
    $
    13,385
    
    
    $
    16,019
    
    
    $
    29,404Total interest expense
    
    
    19,060
    
    
    
    14,464
    
    
    
    33,524$
    (5,675
    )
    
    $
    1,555
    
    
    $
    (4,120
    )
 Nine Months Ended September 30, 2006Rate *
    
    
    Volume *
    
    
    Total *Total interest income
    
    $
    38,121
    
    
    $
    42,446
    
    
    $
    80,567Total interest expense
    
    
    56,714
    
    
    
    35,211
    
    
    
    91,925$
    (18,593
    )
    
    $
    7,235
    
    
    $
    (11,358
    )
 
 *
    
    The change in interest income and interest expense 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. -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
      -16-




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##### Table of Contents



Risk Factors and Critical Accounting Policies
  Accounting for Acquisitions of Mortgage Securities Seller-Financed using Repurchase Arrangements
  Residential Mortgage Investments
   -17-




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##### Table of Contents



.
 Credit-Sensitive Commercial Real Estate-related Assets
     -18-




---



##### Table of Contents



Mortgage Securities and Similar Investments Yield and Cost Analysis
  Projected
    
    
    Lifetime3rdQuarter Average
    
    
    As of September 30, 2006
    
    

4thQuarter
    
    
    RunoffBasis(a)
    
    
    Yield/Cost
    
    
    Runoff
    
    
    Premiums
    
    
    Basis(a)
    
    
    Yield/Cost(b)
    
    
    AssumptionsAgency Securities:Fannie Mae/Freddie Mac:Fixed-rate
    
    $
    19,456
    
    
    
    6.32
    %
    
    
    28
    %
    
    $
    61
    
    
    $
    18,540
    
    
    
    6.41
    %
    
    
    38
    %ARMs
    
    
    3,993,002
    
    
    
    5.04
    
    
    
    31
    
    
    
    59,219
    
    
    
    4,275,049
    
    
    
    5.41
    
    
    
    31Ginnie Mae ARMs
    
    
    855,067
    
    
    
    4.90
    
    
    
    31
    
    
    
    2,616
    
    
    
    821,783
    
    
    
    5.04
    
    
    
    294,867,525
    
    
    
    5.02
    
    
    
    31
    
    
    
    61,896
    
    
    
    5,115,372
    
    
    
    5.35
    
    
    
    31Non-agency Securities:Fixed-rate
    
    
    20,648
    
    
    
    6.43
    
    
    
    34
    
    
    
    49
    
    
    
    19,113
    
    
    
    6.89
    
    
    
    37ARMs
    
    
    35,717
    
    
    
    6.29
    
    
    
    22
    
    
    
    327
    
    
    
    34,326
    
    
    
    6.59
    
    
    
    3856,365
    
    
    
    6.34
    
    
    
    27
    
    
    
    376
    
    
    
    53,439
    
    
    
    6.70
    
    
    
    38Commercial loans
    
    
    1,438
    
    
    
    18.00
    
    
    
    
    
    
    
    
    
    
    
    2,520
    
    
    
    18.00
    
    
    
    Collateral for
structured
financings
    
    
    6,464
    
    
    
    7.75
    
    
    
    13
    
    
    
    98
    
    
    
    6,362
    
    
    
    7.75
    
    
    
    304,931,792
    
    
    
    5.04
    
    
    
    31
    
    
    $
    62,370
    
    
    
    5,177,693
    
    
    
    5.37
    
    
    
    31Related borrowings:30-day LIBOR
    
    
    3,595,026
    
    
    
    5.33
    
    
    
    
    
    
    
    
    
    
    
    3,649,583
    
    
    
    5.31>30-day LIBOR
    
    
    994,008
    
    
    
    4.71
    
    
    
    
    
    
    
    
    
    
    
    1,171,897
    
    
    
    4.83Structured financings
    
    
    6,464
    
    
    
    7.75
    
    
    
    
    
    
    
    
    
    
    
    6,362
    
    
    
    7.754,595,498
    
    
    
    5.20
    
    
    
    
    
    
    
    
    
    
    
    4,827,842
    
    
    
    5.20Capital employed/
financing spread
    
    $
    336,294
    
    
    
    (0.16)
    
    
    
    
    
    
    
    
    
    
    $
    349,851
    
    
    
    0.17Return on assets (c)
    
    
    
    
    
    
    0.09
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.39
 
 (a)
    
    Basis represents the Companys investment before unrealized gains and losses. Asset
yields, runoff rates, borrowing rates and resulting financing spread are presented on an
annualized basis.(b)
    
    Projected annualized yields reflect ARM coupon resets and lifetime runoff assumptions as
adjusted for expected portfolio acquisitions over the next three months and runoff
expectations over the next twelve months, as of October 19, 2006, the date third quarter
earnings were released. Actual yields realized in future periods largely depend upon (i)
changes in portfolio composition, (ii) actual ARM coupon resets, which can fluctuate from
projections based on changes to the underlying indexes, (iii) actual runoff and (iv) any
changes in lifetime runoff assumptions. Interest rates on borrowings that reset every 30
days based on 30-day London Interbank Offered Rate (LIBOR) reflect no changes in the
federal funds rate during the forecast period. Projected average portfolio yields, borrowing
rates, financing spreads and runoff rates over the next four quarters for Capsteads existing
portfolio, (adjusted for expected portfolio acquisitions through December 31, 2006 only), are
as follows: Ending
    
    Portfolio AveragesFederal
    
    
    
    
    
    Borrowing
    
    Financing
    
    RunoffFunds Rate
    
    Yields
    
    Rates
    
    Spreads *
    
    RatesFourth Quarter 2006
    
    
    5.25
    
    
    
    5.37
    
    
    
    5.20
    
    
    
    0.17
    %
    
    
    28
    %First Quarter 2007
    
    
    5.25
    
    
    
    5.60
    
    
    
    5.20
    
    
    
    0.40
    
    
    
    27Second Quarter 2007
    
    
    5.25
    
    
    
    5.69
    
    
    
    5.21
    
    
    
    0.48
    
    
    
    30Third Quarter 2007
    
    
    5.25
    
    
    
    5.86
    
    
    
    5.21
    
    
    
    0.65
    
    
    
    31
 
 *
    
    Financing spreads do not take into account earnings on capital supporting this
portfolio.(c)
    
    The Company generally 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.  -19-




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##### Table of Contents



Book Value per Common Share
  -20-




---



##### Table of Contents



Utilization of Investment Capital and Potential Liquidity
  Related
    
    
    Capital
    
    
    PotentialInvestments(a)
    
    
    Borrowings
    
    
    Employed(a)
    
    
    Liquidity(a)Residential mortgage securities:Agency Securities
    
    $
    5,128,125
    
    
    $
    4,772,493
    
    
    $
    355,632
    
    
    $
    208,515Non-agency Securities
    
    
    53,783
    
    
    
    48,987
    
    
    
    4,796
    
    
    
    447Collateral for structured financings
    
    
    6,362
    
    
    
    6,362
    
    
    
    
    
    
    
    5,188,270
    
    
    
    4,827,842
    
    
    
    360,428
    
    
    
    208,962Commercial real estate-related assets:Commercial loans
    
    
    2,520
    
    
    
    
    
    
    
    2,520
    
    
    
    Investment in Redtail Capital
    
    
    16,980
    
    
    
    
    
    
    
    16,980
    
    
    
    190$
    5,207,770
    
    
    $
    4,827,842
    
    
    
    379,928
    
    
    
    209,152Other assets, net of other liabilities
    
    
    
    
    
    
    
    
    
    
    59,091
    
    
    
    4,195Third quarter common dividend
    
    
    
    
    
    
    
    
    
    
    (381
    )
    
    
    (381)
    (b)$
    438,638
    
    
    $
    212,966Balances as of December 31, 2005
    
    $
    4,374,929
    
    
    $
    4,023,686
    
    
    $
    419,828
    
    
    $
    249,861
 
 (a)
    
    Investments are stated at carrying amounts on the Companys balance sheet. Potential
liquidity is based on maximum amounts of borrowings available under existing uncommitted
repurchase arrangements considering the fair value of related collateral as of the indicated
dates adjusted for other sources (uses) of liquidity such as unrestricted cash and cash
equivalents, cash flow (requirements) distributions from Redtail Capital and dividends
payable.(b)
    
    The third quarter 2006 common dividend was declared September 15, 2006 and paid October 20,
2006 to stockholders of record as of September 30, 2006. -21-




---



##### Table of Contents



Tax Considerations of Dividends Paid on Capstead Common and Preferred Shares
  -22-




---



##### Table of Contents



RESULTS OF OPERATIONS
  Quarter Ended
    
    
    Nine Months EndedSeptember 30
    
    
    September 302006
    
    
    2005
    
    
    2006
    
    
    2005Income statement data:Mortgage securities and similar investments:Agency Securities
    
    $
    989
    
    
    $
    4,636
    
    
    $
    8,716
    
    
    $
    18,501Non-agency Securities
    
    
    110
    
    
    
    296
    
    
    
    430
    
    
    
    1,292CMBS and other commercial loans
    
    
    65
    
    
    
    151
    
    
    
    65
    
    
    
    431Collateral for structured financings
    
    
    
    
    
    
    201
    
    
    
    
    
    
    
    3451,164
    
    
    
    5,284
    
    
    
    9,211
    
    
    
    20,569Other revenue (expense):Other revenue
    
    
    63
    
    
    
    477
    
    
    
    429
    
    
    
    888Interest on unsecured borrowings
    
    
    (1,747
    )
    
    
    (41
    )
    
    
    (4,955
    )
    
    
    (41
    )Other operating expense
    
    
    (1,627
    )
    
    
    (1,531
    )
    
    
    (4,876
    )
    
    
    (4,543
    )(3,311
    )
    
    
    (1,095
    )
    
    
    (9,402
    )
    
    
    (3,696
    )Equity in earnings (losses) of
unconsolidated affiliates
    
    
    654
    
    
    
    (42
    )
    
    
    1,684
    
    
    
    (42
    )Income (loss) from continuing operations
    
    
    (1,493
    )
    
    
    4,147
    
    
    
    1,493
    
    
    
    16,831Income from discontinued operation
    
    
    
    
    
    
    468
    
    
    
    
    
    
    
    1,376Net income (loss)
    
    $
    (1,493
    )
    
    $
    4,615
    
    
    $
    1,493
    
    
    $
    18,207Diluted earnings (loss) per common share:Income (loss) from continuing operations
    
    $
    (0.35
    )
    
    $
    (0.05
    )
    
    $
    (0.73
    )
    
    $
    0.09Income from discontinued operation
    
    
    
    
    
    
    0.03
    
    
    
    
    
    
    
    0.07$
    (0.35
    )
    
    $
    (0.02
    )
    
    $
    (0.73
    )
    
    $
    0.16Key portfolio statistics:Average yields:Agency Securities
    
    
    5.02
    %
    
    
    3.67
    %
    
    
    4.76
    %
    
    
    3.48
    %Non-agency Securities
    
    
    6.34
    
    
    
    5.15
    
    
    
    6.04
    
    
    
    4.98CMBS and other commercial loans
    
    
    18.00
    
    
    
    4.55
    
    
    
    18.00
    
    
    
    4.08Collateral for structured financings
    
    
    7.75
    
    
    
    13.37
    
    
    
    7.31
    
    
    
    5.65Total average yields
    
    
    5.04
    
    
    
    3.75
    
    
    
    4.78
    
    
    
    3.54Average related borrowing rates
    
    
    5.20
    
    
    
    3.31
    
    
    
    4.81
    
    
    
    2.92Average financing spreads
    
    
    (0.16
    )
    
    
    0.44
    
    
    
    (0.03
    )
    
    
    0.62Average portfolio balances:Agency Securities
    
    $
    4,868
    
    
    $
    3,351
    
    
    $
    4,737
    
    
    $
    3,301Non-agency Securities
    
    
    56
    
    
    
    81
    
    
    
    61
    
    
    
    82CMBS and other commercial loans
    
    
    1
    
    
    
    51
    
    
    
    1
    
    
    
    51Collateral for structured financings
    
    
    6
    
    
    
    13
    
    
    
    8
    
    
    
    274,931
    
    
    
    3,496
    
    
    
    4,807
    
    
    
    3,461Related average borrowings
    
    
    4,595
    
    
    
    3,255
    
    
    
    4,471
    
    
    
    3,219Average capital deployed
    
    $
    336
    
    
    $
    241
    
    
    $
    336
    
    
    $
    242Average portfolio runoff rates:Agency Securities
    
    
    31
    %
    
    
    39
    %
    
    
    31
    %
    
    
    33
    %Total
    
    
    31
    
    
    
    37
    
    
    
    31
    
    
    
    32
 -23-




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##### Table of Contents



-24-




---



##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES
    -25-




---



##### Table of Contents



RISK FACTORS
 General Discussion of Effects of Interest Rate Changes
  Fully
    
    
    Average
    
    
    
    
    
    
    Average
    
    
    MonthsNet
    
    
    Indexed
    
    
    Net
    
    
    Average Periodic
    
    
    Lifetime
    
    
    ToARM Type
    
    Basis *
    
    
    WAC
    
    
    WAC
    
    
    Margins
    
    
    Caps
    
    
    Caps
    
    
    RollCurrent-reset ARMs:Agency Securities:Fannie
Mae/Freddie Mac
    
    $
    2,862,268
    
    
    
    5.91
    %
    
    
    6.76
    %
    
    
    1.84
    %
    
    
    3.73
    %
    
    
    10.77
    %
    
    
    5.4Ginnie Mae
    
    
    821,783
    
    
    
    4.98
    
    
    
    6.41
    
    
    
    1.54
    
    
    
    1.00
    
    
    
    9.83
    
    
    
    5.7Non-agency Securities
    
    
    34,326
    
    
    
    6.77
    
    
    
    7.49
    
    
    
    2.11
    
    
    
    1.72
    
    
    
    11.32
    
    
    
    5.63,718,377
    
    
    
    5.72
    
    
    
    6.69
    
    
    
    1.78
    
    
    
    3.11
    
    
    
    10.57
    
    
    
    5.5Longer-to-reset ARMs:Agency Securities:Fannie
Mae/Freddie Mac
    
    
    1,412,781
    
    
    
    6.00
    
    
    
    7.14
    
    
    
    1.82
    
    
    
    3.97
    
    
    
    11.84
    
    
    
    43.4$
    5,131,158
    
    
    
    5.79
    
    
    
    6.81
    
    
    
    1.79
    
    
    
    3.34
    
    
    
    10.92
    
    
    
    15.9
 
 *
    
    Basis represents the Companys investment before unrealized gains and losses. -26-




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Interest Rate Sensitivity on Operating Results
 Other revenue (expense)
 -27-




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##### Table of Contents



30-day
    
    10-year U.S.LIBOR
    
    TreasuryRate
    
    Rate
    
    Immediate Change In:*30-day LIBOR rate
    
    
    
    
    
    
    
    
    
    Down 1.00%
    
    Down 1.00%
    
    Flat
    
    Up 
1.00%
    
    Up   
1.00%10-year U.S. Treasury rate
    
    
    
    
    
    
    
    
    
    Down 1.00%
    
    Flat
    
    Down 
1.00%
    
    Flat
    
    
    UP 1.00%Projected 12-month
earnings change:September 30, 2006
**
    
    
    5.32
    %
    
    
    4.63
    %
    
    $
    15,500
    
    
    $
    18,000
    
    
    $
    (5,600
    )
    
    $
    (25,700
    )
    
    $
    (22,500
    )December 31, 2005
    
    
    4.39
    
    
    
    4.40
    
    
    
    12,400
    
    
    
    14,300
    
    
    
    (4,300
    )
    
    
    (21,000
    )
    
    
    (19,600
    )
 
 *
    
    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
assurance 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.**
    
    Increased earnings sensitivity as of September 30, 2006 primarily reflects the increased
size of the Companys residential mortgage securities portfolio. Risks Associated With Credit-Sensitive Investments
    -28-




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-29-




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##### Table of Contents



Tax Status
    Investment Company Act of 1940
   CRITICAL ACCOUNTING POLICIES
  -30-




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
    
    Amortization of Investment Premiums on Financial Assets
Investment premiums on financial assets are recognized in earnings
as adjustments to interest income by the interest method over the
estimated lives of the related assets. 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. Management
estimates mortgage prepayments based on past experiences with
specific investments within the portfolio, and current market
expectations for changes in the interest rate environment. Should
actual runoff rates differ materially from these estimates,
investment premiums would be expensed at a different pace.
    
    Fair Value and Impairment Accounting for Financial Assets Most
of Capsteads investments are financial assets held in the form of
mortgage securities that are classified as held available-for-sale
and recorded at fair value on the balance sheet with unrealized
gains and losses recorded in Stockholders equityas a component
of Accumulated other comprehensive income (loss). As such, these
unrealized gains and losses enter into the calculation of book
value per common share, a key financial metric used by investors
in evaluating the Company, and a factor in determining incentive
compensation and therefore earnings of the Company. 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 9 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.
 FORWARD LOOKING STATEMENTS
  -31-




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS
  
 ITEM 4. CONTROLS AND PROCEDURES
  
 PART II. 3⁄4 OTHER INFORMATION
 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 (a)
    
    Exhibits: The following Exhibits are presented herewith: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 July 21, 2006 furnishing the press release announcing second
quarter 2006 results.Current Report on Form 8-K dated August 16, 2006 announcing the granting of stock compensation
to a new employee.Current Report on Form 8-K dated August 25, 2006 to file an investment community presentation.Current Report on Form 8-K dated September 14, 2006 to file material agreements pertaining to
the September 11, 2006 private placement of $25 million in trust preferred securities.
 -32-




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SIGNATURES
  CAPSTEAD MORTGAGE CORPORATIONRegistrantDate: November 6, 2006
    
    By:
    
    /s/ ANDREW F. JACOBSAndrew F. JacobsPresident and Chief Executive OfficerDate: November 6, 2006
    
    By:
    
    /s/ PHILLIP A. REINSCHPhillip A. ReinschExecutive Vice President andChief Financial Officer
 -33-