##### 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: March 31, 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
  Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer o
 o þ
 APPLICABLE ONLY TO CORPORATE ISSUERS:
  Common Stock ($0.01 par value)
    19,043,154 as of May 5, 2006




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##### 



CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2006
 INDEX
 PagePART I. 3⁄4 FINANCIAL INFORMATIONITEM 1. Financial StatementsConsolidated Balance Sheets 3⁄4 March 31, 2006 and December 31, 2005
    
    
    3Consolidated Statements of Operations 3⁄4 Quarter Ended March 31, 2006 and 2005
    
    
    4Consolidated Statements of Cash Flows 3⁄4 Quarter Ended March 31, 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
    
    
    31ITEM 4. Controls and Procedures
    
    
    31PART II. 3⁄4 OTHER INFORMATIONITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    31ITEM 6. Exhibits and Reports on Form 8-K
    
    
    32SIGNATURES
    
    
    33Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock DividendsCertification Pursuant to Section 302Certification Pursuant to Section 302Certification 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)
 March 31, 2006

    December 31, 2005(unaudited)
    
    
    (NOTE 2)Assets:Mortgage securities and similar investments
($4.6 billion pledged under repurchase arrangements)
    
    $
    4,790,993
    
    
    $
    4,368,025Investments in unconsolidated affiliates
    
    
    18,692
    
    
    
    9,246Receivables and other assets
    
    
    57,655
    
    
    
    53,040Cash and cash equivalents
    
    
    23,700
    
    
    
    33,937$
    4,891,040
    
    
    $
    4,464,248Liabilities:Repurchase arrangements and similar borrowings
    
    $
    4,465,053
    
    
    $
    4,023,686Unsecured borrowings
    
    
    77,321
    
    
    
    77,321Liabilities of discontinued operation
    
    
    
    
    
    
    2,884Common stock dividend payable
    
    
    381
    
    
    
    381Accounts payable and accrued expenses
    
    
    13,569
    
    
    
    15,1274,556,324
    
    
    
    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
March 31, 2006 and December 31, 2005
($3,317 aggregate liquidation preference)
    
    
    2,827
    
    
    
    2,827$1.26 Cumulative Convertible Preferred Stock, Series B,
15,819 shares issued and outstanding at
March 31, 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
March 31, 2006 and December 31, 2005
    
    
    191
    
    
    
    191Paid-in capital
    
    
    510,334
    
    
    
    512,933Accumulated deficit
    
    
    (352,803
    )
    
    
    (352,803
    )Accumulated other comprehensive income (loss)
    
    
    (2,538
    )
    
    
    4,996334,716
    
    
    
    344,849$
    4,891,040
    
    
    $
    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 March 312006
    
    
    2005Mortgage securities and similar investments:Interest income
    
    $
    52,926
    
    
    $
    28,523Interest expense
    
    
    (47,543
    )
    
    
    (20,033
    )5,383
    
    
    
    8,490Other revenue (expense):Other revenue
    
    
    166
    
    
    
    196Interest expense on unsecured borrowings
    
    
    (1,587
    )
    
    
    Other operating expense
    
    
    (1,673
    )
    
    
    (1,530
    )(3,094
    )
    
    
    (1,334
    )Income before equity in earnings of unconsolidated affiliates
and discontinued operation
    
    
    2,289
    
    
    
    7,156Equity in earnings of unconsolidated affiliates
    
    
    422
    
    
    
    Income from continuing operations
    
    
    2,711
    
    
    
    7,156Income from discontinued operation
    
    
    
    
    
    
    446Net income
    
    $
    2,711
    
    
    $
    7,602Net income available (loss attributable) to common
stockholders:Net income
    
    $
    2,711
    
    
    $
    7,602Less cash dividends paid on preferred shares
    
    
    (5,064
    )
    
    
    (5,064
    )$
    (2,353
    )
    
    $
    2,538Basic and diluted earnings (loss) per common share:Income (loss) from continuing operations
    
    $
    (0.12
    )
    
    $
    0.11Income from discontinued operation
    
    
    
    
    
    
    0.02$
    (0.12
    )
    
    $
    0.13Cash dividends declared per share:Common
    
    $
    0.020
    
    
    $
    0.180Series A Preferred
    
    
    0.400
    
    
    
    0.400Series B Preferred
    
    
    0.315
    
    
    
    0.315
 See accompanying notes to consolidated financial statements.
 -4-




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CAPSTEAD MORTGAGE CORPORATION
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 (unaudited)
 Quarter Ended March 312006
    
    
    2005Operating activities:Net income
    
    $
    2,711
    
    
    $
    7,602Noncash items:Amortization of investment premiums
    
    
    5,967
    
    
    
    4,879Depreciation and other amortization
    
    
    109
    
    
    
    61Undistributed earnings of unconsolidated affiliates
    
    
    (228
    )
    
    
    Net change in receivables, other assets, accounts payable and
accrued expenses
    
    
    (3,212
    )
    
    
    (1,067
    )Net cash provided by operating activities of continuing operations
    
    
    5,347
    
    
    
    11,475Net cash provided by operating activities of discontinued operation
    
    
    
    
    
    
    693Net cash provided by operating activities
    
    
    5,347
    
    
    
    12,168Investing activities:Purchases of mortgage securities and similar investments
    
    
    (842,261
    )
    
    
    (302,735
    )Principal collections on mortgage securities and similar investments
    
    
    402,797
    
    
    
    290,373Investments in unconsolidated affiliate  commercial real estate
loan limited partnership
    
    
    (9,218
    )
    
    
    Net cash used in investing activities of continuing operations
    
    
    (448,682
    )
    
    
    (12,362
    )Net cash used in investing activities of discontinued operation
    
    
    (2,884
    )
    
    
    Net cash used in investing activities
    
    
    (451,566
    )
    
    
    (12,362
    )Financing activities:Net increase (decrease) in repurchase arrangements and similar
borrowings
    
    
    441,377
    
    
    
    (59,517
    )Capital stock transactions
    
    
    50
    
    
    
    35Dividends paid
    
    
    (5,445
    )
    
    
    (9,215
    )Net cash provided by (used in) financing activities of continuing
operations
    
    
    435,982
    
    
    
    (68,697
    )Net cash used in financing activities of discontinued operation
    
    
    
    
    
    
    (60
    )Net cash provided by (used in) financing activities
    
    
    435,982
    
    
    
    (68,757
    )Net change in cash and cash equivalents
    
    
    (10,237
    )
    
    
    (68,951
    )Cash and cash equivalents at beginning of period
    
    
    33,937
    
    
    
    73,030Cash and cash equivalents at end of period
    
    $
    23,700
    
    
    $
    4,079
 See accompanying notes to consolidated financial statements.
 -5-




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CAPSTEAD MORTGAGE CORPORATION
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31, 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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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 from continuing operations Income from discontinued operation
 -7-




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##### Table of Contents



Quarter Ended March 312006
    
    
    2005Numerators for basic earnings (loss) per common share:Income from continuing operations
    
    $
    2,711
    
    
    $
    7,156Less Series A and B preferred share dividends
    
    
    (5,064
    )
    
    
    (5,064
    )Income from continuing operations available (loss attributable)
to common stockholders
    
    
    (2,353
    )
    
    
    2,092Income from discontinued operation
    
    
    
    
    
    
    446$
    (2,353
    )
    
    $
    2,538Weighted average common shares outstanding
    
    
    18,872
    
    
    
    18,860Basic earnings (loss) per common share:Income (loss) from continuing operations
    
    $
    (0.12
    )
    
    $
    0.11Income from discontinued operation
    
    
    
    
    
    
    0.02$
    (0.12
    )
    
    $
    0.13Numerators for diluted earnings (loss) per common share:Income from continuing operations
    
    $
    2,711
    
    
    $
    7,156Less dividends on antidilutive convertible preferred shares
    
    
    (5,064
    )
    
    
    (5,064
    )Income from continuing operations available (loss attributable)
to common stockholders
    
    
    (2,353
    )
    
    
    2,092Income from discontinued operation
    
    
    
    
    
    
    446$
    (2,353
    )
    
    $
    2,538Denominator for diluted earnings (loss) per common share:Weighted average common shares outstanding
    
    
    18,872
    
    
    
    18,860Net effect of dilutive stock options
    
    
    
    
    
    
    25Net effect of dilutive convertible preferred shares
    
    
    
    
    
    
    18,872
    
    
    
    18,885Diluted earnings (loss) per common share:Income (loss) from continuing operations
    
    $
    (0.12
    )
    
    $
    0.11Income from discontinued operation
    
    
    
    
    
    
    0.02$
    (0.12
    )
    
    $
    0.13Antidilutive securities excluded from the calculation
of diluted earnings (loss) per common share:Nonvested stock grants and shares issuable under stock options
    
    
    867
    
    
    
    318Series A preferred shares
    
    
    202
    
    
    
    202Series B preferred shares
    
    
    15,819
    
    
    
    15,819
 NOTE 4 3⁄4 MORTGAGE SECURITIES AND SIMILAR INVESTMENTS
  -8-




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Mortgage securities and similar investments
 Average
    
    
    AveragePrincipal
    
    
    Investment
    
    
    
    
    
    
    Carrying
    
    
    Coupon
    
    
    EffectiveBalance
    
    
    Premiums
    
    
    Basis
    
    
    Amount(a)
    
    
    Rate(b)
    
    
    Rate(b)March 31, 2006Agency Securities:Fannie Mae/Freddie Mac:Fixed-rate
    
    $
    21,943
    
    
    $
    77
    
    
    $
    22,020
    
    
    $
    22,053
    
    
    
    6.63
    %
    
    
    6.32
    %ARMs
    
    
    3,726,719
    
    
    
    57,590
    
    
    
    3,784,309
    
    
    
    3,778,939
    
    
    
    5.40
    
    
    
    4.53Ginnie Mae ARMs
    
    
    912,844
    
    
    
    3,105
    
    
    
    915,949
    
    
    
    918,195
    
    
    
    4.61
    
    
    
    4.334,661,506
    
    
    
    60,772
    
    
    
    4,722,278
    
    
    
    4,719,187
    
    
    
    5.25
    
    
    
    4.50Non-agency Securities:Fixed-rate
    
    
    23,849
    
    
    
    89
    
    
    
    23,938
    
    
    
    23,999
    
    
    
    7.14
    
    
    
    6.48ARMs
    
    
    39,027
    
    
    
    406
    
    
    
    39,433
    
    
    
    39,729
    
    
    
    5.92
    
    
    
    5.2762,876
    
    
    
    495
    
    
    
    63,371
    
    
    
    63,728
    
    
    
    6.38
    
    
    
    5.74Collateral for structured
financings
    
    
    7,955
    
    
    
    123
    
    
    
    8,078
    
    
    
    8,078
    
    
    
    8.14
    
    
    
    7.34$
    4,732,337
    
    
    $
    61,390
    
    
    $
    4,793,727
    
    
    $
    4,790,993
    
    
    
    5.27
    
    
    
    4.52December 31, 2005Agency Securities:Fannie Mae/Freddie Mac:Fixed-rate
    
    $
    23,547
    
    
    $
    87
    
    
    $
    23,634
    
    
    $
    23,670
    
    
    
    6.63
    %
    
    
    6.21
    %ARMs
    
    
    3,268,374
    
    
    
    54,792
    
    
    
    3,323,166
    
    
    
    3,324,118
    
    
    
    5.13
    
    
    
    3.63Ginnie Mae ARMs
    
    
    933,897
    
    
    
    4,222
    
    
    
    938,119
    
    
    
    941,542
    
    
    
    4.46
    
    
    
    3.544,225,818
    
    
    
    59,101
    
    
    
    4,284,919
    
    
    
    4,289,330
    
    
    
    4.99
    
    
    
    3.62Non-agency Securities:Fixed-rate
    
    
    26,493
    
    
    
    114
    
    
    
    26,607
    
    
    
    26,689
    
    
    
    7.12
    
    
    
    6.40ARMs
    
    
    42,150
    
    
    
    467
    
    
    
    42,617
    
    
    
    42,908
    
    
    
    5.33
    
    
    
    4.3368,643
    
    
    
    581
    
    
    
    69,224
    
    
    
    69,597
    
    
    
    6.02
    
    
    
    5.09CMBS  adjustable-rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4.27Collateral for structured
financings
    
    
    8,960
    
    
    
    138
    
    
    
    9,098
    
    
    
    9,098
    
    
    
    7.80
    
    
    
    5.76$
    4,303,421
    
    
    $
    59,820
    
    
    $
    4,363,241
    
    
    $
    4,368,025
    
    
    
    5.01
    
    
    
    3.68
 
 (a)
    
    Includes mark-to-market for securities classified as available-for-sale, if applicable
(see NOTE 9).(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 investment premiums, mortgage insurance costs on Non-agency
Securities and excluding unrealized gains and losses. -9-




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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
 Mortgage securities and similar investments
 -10-




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March 31, 2006
    
    
    December 31, 2005Borrowings
    
    
    Average
    
    
    Borrowings
    
    
    AverageOutstanding
    
    
    Rate
    
    
    Outstanding
    
    
    RateBorrowings with maturities of 30 days or less:Agency Securities
    
    $
    3,456,049
    
    
    
    4.66
    %
    
    $
    3,133,090
    
    
    
    4.23
    %Non-agency Securities
    
    
    58,089
    
    
    
    5.31
    
    
    
    63,734
    
    
    
    4.883,514,138
    
    
    
    4.67
    
    
    
    3,196,824
    
    
    
    4.24Borrowings with maturities greater than 30 days:Agency Securities (31 to 90 days)
    
    
    198,209
    
    
    
    2.91
    
    
    
    25,000
    
    
    
    3.25Agency Securities (91 to 360 days)
    
    
    190,224
    
    
    
    4.07
    
    
    
    331,907
    
    
    
    2.79Agency Securities (greater than 360 days)
    
    
    554,404
    
    
    
    4.71
    
    
    
    460,857
    
    
    
    4.50942,837
    
    
    
    4.20
    
    
    
    817,764
    
    
    
    3.77Collateral for structured financings
    
    
    8,078
    
    
    
    7.34
    
    
    
    9,098
    
    
    
    7.49$
    4,465,053
    
    
    
    4.58
    
    
    $
    4,023,686
    
    
    
    4.15
 Repurchase arrangements and similar borrowings
 NOTE 8 3⁄4 UNSECURED BORROWINGS
 Unsecured borrowings
 March 31, 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
    
    
    
    8.45
    
    
    
    41,238
    
    
    
    8.45$
    77,321
    
    
    
    8.39
    
    
    $
    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
  March 31, 2006
    
    
    December 31, 2005Fair
    
    
    Unrealized
    
    
    Fair
    
    
    UnrealizedValue
    
    
    Loss
    
    
    Value
    
    
    LossSecurities in unrealized loss position:One year or greater
    
    $
    689,013
    
    
    $
    9,575
    
    
    $
    472,584
    
    
    $
    6,313Less than one year
    
    
    1,833,343
    
    
    
    10,864
    
    
    
    1,431,465
    
    
    
    8,611$
    2,522,356
    
    
    $
    20,439
    
    
    $
    1,904,049
    
    
    $
    14,924
  Gross
    
    
    GrossCost
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairBasis
    
    
    Gains
    
    
    Losses
    
    
    ValueAs of March 31, 2006Agency Securities:Fixed-rate
    
    $
    427
    
    
    $
    33
    
    
    $
    
    
    
    $
    460ARMs
    
    
    4,700,258
    
    
    
    17,262
    
    
    
    20,386
    
    
    
    4,697,1344,700,685
    
    
    
    17,295
    
    
    
    20,386
    
    
    
    4,697,594Non-agency Securities
    
    
    31,761
    
    
    
    372
    
    
    
    15
    
    
    
    32,118$
    4,732,446
    
    
    $
    17,667
    
    
    $
    20,401
    
    
    $
    4,729,712As 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
    
    
    GrossCost
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairBasis
    
    
    Gains
    
    
    Losses
    
    
    ValueAs of March 31, 2006Collateral released from structured
financings:Agency Securities
    
    $
    21,593
    
    
    $
    392
    
    
    $
    4
    
    
    $
    21,981Non-agency Securities
    
    
    31,610
    
    
    
    468
    
    
    
    34
    
    
    
    32,044Collateral for structured financings
    
    
    8,078
    
    
    
    
    
    
    
    
    
    
    
    8,078$
    61,281
    
    
    $
    860
    
    
    $
    38
    
    
    $
    62,103As 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 March 312006
    
    
    2005Net income
    
    $
    2,711
    
    
    $
    7,602Other comprehensive loss:Amounts related to cash flow hedges:Reclassification adjustment for amounts included in net income
    
    
    (16
    )
    
    
    (34
    )Amounts related to discontinued operation
    
    
    
    
    
    
    (13
    )Amounts related to securities held available-for-sale:Change in valuation of mortgage securities held
available-for-sale
    
    
    (7,518
    )
    
    
    (5,121
    )Other comprehensive loss
    
    
    (7,534
    )
    
    
    (5,168
    )Comprehensive income (loss)
    
    $
    (4,823
    )
    
    $
    2,434
 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
    
    
    
    
    
    
    Forfeitures
    
    
    (1,600
    )
    
    
    7.82Vested
    
    
    
    
    
    
    As of March 31, 2006
    
    
    171,000
    
    
    
    7.86
  Stock Option Grant Activity
 Number of
    
    Weighted AverageShares
    
    Exercise PriceAs of December 31, 2005 (419,782 exercisable at
$21.87)
    
    
    777,669
    
    
    $
    15.33Grants
    
    
    
    
    
    
    Forfeitures
    
    
    (5,000
    )
    
    
    7.82Expirations
    
    
    (76,348
    )
    
    
    22.86Exercises
    
    
    
    
    
    
    As of March 31, 2006 (341,321 exercisable at $21.56)
    
    
    696,321
    
    
    
    14.55
   -14-




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##### Table of Contents



NOTE 12 3⁄4 NET INTEREST INCOME ANALYSIS
 Unsecured
borrowings
 Quarter Ended March 312006
    
    
    2005Average
    
    
    
    
    
    
    AverageEffective
    
    
    
    
    
    
    EffectiveAmount
    
    
    Rate
    
    
    Amount
    
    
    RateInterest income
    
    $
    52,926
    
    
    
    4.52
    %
    
    $
    28,523
    
    
    
    3.33
    %Interest expense
    
    
    (47,543
    )
    
    
    4.38
    
    
    
    (20,033
    )
    
    
    2.51$
    5,383
    
    
    
    0.14
    
    
    $
    8,490
    
    
    
    0.82
  Rate *
    
    
    Volume *
    
    
    Total *Total interest income
    
    $
    12,021
    
    
    $
    12,382
    
    
    $
    24,403Total interest expense
    
    
    18,509
    
    
    
    9,001
    
    
    
    27,510$
    (6,488
    )
    
    $
    3,381
    
    
    $
    (3,107
    )
 
 *
    
    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
  Mortgage Securities and Similar Investments
   -17-




---



##### Table of Contents



Projected
    
    
    Lifetime1st Quarter Average
    
    
    As of March 31, 2006
    
    
    2nd Quarter
    
    
    RunoffBasis(a)
    
    
    Yield/Cost
    
    
    Runoff
    
    
    Premiums
    
    
    Basis(a)
    
    
    Yield/Cost(b)
    
    
    AssumptionsAgency Securities:Fannie Mae/Freddie Mac:Fixed-rate
    
    $
    22,966
    
    
    
    6.32
    %
    
    
    25
    %
    
    $
    77
    
    
    $
    22,020
    
    
    
    6.37
    %
    
    
    38
    %ARMs
    
    
    3,641,470
    
    
    
    4.53
    
    
    
    30
    
    
    
    57,590
    
    
    
    3,784,309
    
    
    
    4.77
    
    
    
    32Ginnie Mae ARMs
    
    
    940,612
    
    
    
    4.33
    
    
    
    29
    
    
    
    3,105
    
    
    
    915,949
    
    
    
    4.57
    
    
    
    294,605,048
    
    
    
    4.50
    
    
    
    30
    
    
    
    60,772
    
    
    
    4,722,278
    
    
    
    4.74
    
    
    
    31Non-agency Securities:Fixed-rate
    
    
    25,552
    
    
    
    6.48
    
    
    
    34
    
    
    
    89
    
    
    
    23,938
    
    
    
    6.83
    
    
    
    37ARMs
    
    
    41,166
    
    
    
    5.27
    
    
    
    26
    
    
    
    406
    
    
    
    39,433
    
    
    
    5.90
    
    
    
    3866,718
    
    
    
    5.74
    
    
    
    29
    
    
    
    495
    
    
    
    63,371
    
    
    
    6.25
    
    
    
    38Collateral for
structured
financings
    
    
    8,765
    
    
    
    7.34
    
    
    
    35
    
    
    
    123
    
    
    
    8,078
    
    
    
    7.24
    
    
    
    304,680,531
    
    
    
    4.52
    
    
    
    30
    
    
    $
    61,390
    
    
    
    4,793,727
    
    
    
    4.76
    
    
    
    31Related borrowings:30-day LIBOR
    
    
    3,323,637
    
    
    
    4.51
    
    
    
    
    
    
    
    
    
    
    
    3,410,593
    
    
    
    4.95>30-day LIBOR
    
    
    1,007,292
    
    
    
    3.92
    
    
    
    
    
    
    
    
    
    
    
    1,046,382
    
    
    
    4.31Structured financings
    
    
    8,765
    
    
    
    7.34
    
    
    
    
    
    
    
    
    
    
    
    8,078
    
    
    
    7.244,339,694
    
    
    
    4.38
    
    
    
    
    
    
    
    
    
    
    
    4,465,053
    
    
    
    4.82Capital employed/
financing spread
    
    $
    340,837
    
    
    
    0.14
    
    
    
    
    
    
    
    
    
    
    $
    328,674
    
    
    
    (0.06
    )Return on assets (c)
    
    
    
    
    
    
    0.46
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.25
 
 (a)
    
    Basis represents the Company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 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 the date of this press release. Actual
yields realized in future periods largely depend upon (i) changes in portfolio composition,
(ii) actual 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 expectations for a 25 basis point increase in the
federal funds to a 5.00% rate at the May 10, 2006 Federal Reserve meeting. Projected average
portfolio yields, borrowing rates, financing spreads and runoff rates over the next four
quarters for Capsteads existing portfolio, (adjusted for expected acquisitions through June
30, 2006 only), are as follows: Portfolio
    
    Borrowing
    
    Financing
    
    RunoffYields
    
    Rates
    
    Spreads *
    
    RatesSecond Quarter 2006
    
    
    4.76
    %
    
    
    4.82
    %
    
    
    (0.06
    )%
    
    
    32
    %Third Quarter 2006
    
    
    5.08
    
    
    
    4.98
    
    
    
    0.10
    
    
    
    31Fourth Quarter 2006
    
    
    5.36
    
    
    
    4.98
    
    
    
    0.38
    
    
    
    28First Quarter 2007
    
    
    5.54
    
    
    
    4.98
    
    
    
    0.56
    
    
    
    29
 
 *
    
    Financing spreads do not take into account earnings on capital supporting
this portfolio.(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. -18-




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Investment in Redtail Capital
  -19-




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##### Table of Contents



Book Value per Common Share
   Utilization of Investment Capital and Potential Liquidity
  -20-




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##### Table of Contents



Related
    
    
    Capital
    
    
    PotentialInvestments(a)
    
    
    Borrowings
    
    
    Employed(a)
    
    
    Liquidity(a)Mortgage securities and similar
investments:Agency Securities
    
    $
    4,719,187
    
    
    $
    4,398,886
    
    
    $
    320,301
    
    
    $
    194,785Non-agency Securities
    
    
    63,728
    
    
    
    58,089
    
    
    
    5,639
    
    
    
    96Collateral for structured financings
    
    
    8,078
    
    
    
    8,078
    
    
    
    
    
    
    
    4,790,993
    
    
    
    4,465,053
    
    
    
    325,940
    
    
    
    194,881Investment in Redtail Capital
    
    
    16,352
    
    
    
    
    
    
    
    16,352
    
    
    
    190$
    4,807,345
    
    
    $
    4,465,053
    
    
    
    342,292
    
    
    
    195,071Other assets, net of other liabilities
    
    
    
    
    
    
    
    
    
    
    67,786
    
    
    
    23,700
    (b)First quarter common dividend
    
    
    
    
    
    
    
    
    
    
    (381
    )
    
    
    (381)
    (c)$
    409,697
    
    
    $
    218,390Balances of as 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)
    
    Represents unrestricted cash and cash equivalents.(c)
    
    The first quarter 2006 common dividend was declared March 16, 2006 and paid April 20, 2006
to stockholders of record as of March 31, 2006.  -21-




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##### Table of Contents



RESULTS OF OPERATIONS
  Quarter Ended March 312006
    
    
    2005Income statement data:Mortgage securities and similar investments:Agency Securities
    
    $
    5,203
    
    
    $
    7,749Non-agency Securities
    
    
    180
    
    
    
    521CMBS and other commercial loans
    
    
    
    
    
    
    136Collateral for structured financings
    
    
    
    
    
    
    845,383
    
    
    
    8,490Other revenue (expense):Other revenue
    
    
    166
    
    
    
    196Interest on unsecured borrowings
    
    
    (1,587
    )
    
    
    Other operating expense
    
    
    (1,673
    )
    
    
    (1,530
    )(3,094
    )
    
    
    (1,334
    )Equity in earnings of unconsolidated affiliates
    
    
    422
    
    
    
    Income from continuing operations
    
    
    2,711
    
    
    
    7,156Income from discontinued operation
    
    
    
    
    
    
    446Net income
    
    $
    2,711
    
    
    $
    7,602Diluted earnings (loss) per common share:Income (loss) from continuing operations
    
    $
    (0.12
    )
    
    $
    0.11Income from discontinued operation
    
    
    
    
    
    
    0.02$
    (0.12
    )
    
    $
    0.13Key portfolio statistics:Average yields:Agency Securities
    
    
    4.50
    %
    
    
    3.29
    %Non-agency Securities
    
    
    5.74
    
    
    
    4.72CMBS and other commercial loans
    
    
    
    
    
    
    3.61Collateral for structured financings
    
    
    7.34
    
    
    
    3.26Total average yields
    
    
    4.52
    
    
    
    3.33Average related borrowing rate
    
    
    4.38
    
    
    
    2.51Average financing spread
    
    
    0.14
    
    
    
    0.82Average portfolio balances:Agency Securities
    
    $
    4,605
    
    
    $
    3,241Non-agency Securities
    
    
    67
    
    
    
    86CMBS and other commercial loans
    
    
    
    
    
    
    51Collateral for structured financings
    
    
    9
    
    
    
    424,681
    
    
    
    3,420Related average borrowings
    
    
    4,340
    
    
    
    3,181Average capital deployed
    
    $
    341
    
    
    $
    239Average portfolio runoff rate:Agency Securities
    
    
    30
    %
    
    
    28
    %Total
    
    
    30
    
    
    
    22
 -22-




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##### Table of Contents



-23-




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##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES
     -24-




---



##### Table of Contents



RISK FACTORS
 General Discussion of Effects of Interest Rate Changes
  Average
    
    
    Average
    
    
    Average
    
    
    MonthsCoupon
    
    
    Periodic
    
    
    Lifetime
    
    
    ToARM Type
    
    Basis *
    
    
    Rate
    
    
    Cap
    
    
    Cap
    
    
    RollCurrent-reset ARMs:Agency Securities:Fannie
Mae/Freddie Mac
    
    $
    2,547,376
    
    
    
    5.35
    %
    
    
    3.04
    %
    
    
    10.98
    %
    
    
    6.1Ginnie Mae
    
    
    915,949
    
    
    
    4.61
    
    
    
    1.00
    
    
    
    9.83
    
    
    
    6.3Non-agency Securities
    
    
    39,433
    
    
    
    5.92
    
    
    
    1.72
    
    
    
    11.34
    
    
    
    5.73,502,758
    
    
    
    5.16
    
    
    
    2.49
    
    
    
    10.68
    
    
    
    6.1Longer-to-reset ARMs:Agency Securities:Fannie
Mae/Freddie Mac
    
    
    1,236,933
    
    
    
    5.49
    
    
    
    4.56
    
    
    
    11.36
    
    
    
    37.7$
    4,739,691
    
    
    
    5.25
    
    
    
    3.03
    
    
    
    10.86
    
    
    
    14.4
 
 *
    
    Basis represents the Companys investment before unrealized gains and losses.  -25-




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##### Table of Contents



Interest Rate Sensitivity on Operating Results
 Other revenue (expense)
  -26-




---



##### Table of Contents



10-year30-day
    
    U.S.LIBOR
    
    TreasuryRate
    
    Rate
    
    Immediate Change In:*Down
    
    Down
    
    
    
    
    

Up
    

Up30-day LIBOR rate
    
    
    
    
    
    
    
    
    
    
    1.00
    %
    
    
    1.00
    %
    
    Flat
    
    
    1.00
    %
    
    
    1.00
    %Down
    
    
    
    
    
    Down
    
    
    
    
    
    Up10-year U.S. Treasury rate
    
    
    
    
    
    
    
    
    
    
    1.00
    %
    
    Flat
    
    
    1.00
    %
    
    Flat
    
    
    1.00
    %Projected 12-month
earnings change:March 31, 2006 **
    
    
    4.83
    %
    
    
    4.85
    %
    
    $
    16,260
    
    
    $
    18,150
    
    
    $
    (4,274
    )
    
    $
    (23,889
    )
    
    $
    (22,606
    )December 31, 2005
    
    
    4.39
    
    
    
    4.40
    
    
    
    12,431
    
    
    
    14,277
    
    
    
    (4,299
    )
    
    
    (20,991
    )
    
    
    (19,628
    )
 
 *
    
    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 March 31, 2006 reflects the increased size of the
Companys mortgage securities and similar investments portfolio. Risks Associated With Credit-Sensitive Investments
    -27-




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##### Table of Contents



Tax Status
  -28-




---



##### Table of Contents



Investment Company Act of 1940
   CRITICAL ACCOUNTING POLICIES
  -29-




---



##### Table of Contents




    
    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
  -30-




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS
  
 ITEM 4. CONTROLS AND PROCEDURES
  
 PART II. 3⁄4 OTHER INFORMATION
 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 (a)
    
    The annual meeting of stockholders was held April 20, 2006.(b)
    
    The board members included in (c) below were elected to Capsteads Board of Directors
(constituting the entire Board of Directors).(c)
    
    The following items were voted on at the annual meeting:
 Withheld/
    
    BrokerFor
    
    Against
    
    Abstentions
    
    Non-votes
    
    Election of board members:Jack Biegler
    
    
    17,326,518
    
    
    
    
    
    
    
    590,666
    
    
    
    Andrew F. Jacobs
    
    
    17,305,463
    
    
    
    
    
    
    
    611,721
    
    
    
    Gary Keiser
    
    
    17,325,714
    
    
    
    
    
    
    
    591,470
    
    
    
    Paul M. Low
    
    
    17,291,295
    
    
    
    
    
    
    
    625,889
    
    
    
    Christopher W. Mahowald
    
    
    17,327,726
    
    
    
    
    
    
    
    589,458
    
    
    
    Michael G. ONeil
    
    
    17,327,442
    
    
    
    
    
    
    
    589,742
    
    
    
    Howard Rubin
    
    
    17,189,324
    
    
    
    
    
    
    
    727,860
    
    
    
    Mark S. Whiting
    
    
    17,168,831
    
    
    
    
    
    
    
    748,353
    
    
    
    
    
    Re-approval of the CapsteadMortgage Corporation Second Amended andRestated Incentive Bonus Plan
    
    
    16,027,855
    
    
    
    1,544,368
    
    
    
    344,961
    
    
    
    
    
    Ratify Appointment of Ernst &Young LLP as the Companys independentregistered public accounting firm for 2006
    
    
    17,520,035
    
    
    
    307,577
    
    
    
    89,572
    
    
    
    
    
    Other matters (no other matters)
 -31-




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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 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 January 4, 2006 announcing the Stock Purchase Agreement by
and between Brookdale Living Communities, Inc. and the Company regarding the sale of the stock
of CMCP Properties, Inc.Current Report on Form 8-K dated January 24, 2006 approving 2005 performance-based incentive
compensation payments to the Companys executive management team.Current Report on Form 8-K dated January 30, 2006 furnishing the press release announcing
fourth quarter 2005 results, setting the record date for annual meeting and establishing the
common dividend schedule for 2006.Current Report on Form 8-K dated January 31, 2006 amending and restating bylaws of Capstead
Mortgage Corporation as of January 26, 2006.Current Report on Form 8-K dated February 23, 2006 amending and restating the Deferred
Compensation Plan effective January 1, 2005.Current Report on Form 8-K dated April 20, 2006 furnishing the press release announcing first
quarter 2006 results.Current Report on Form 8-K dated April 20, 2006 to file the Capstead Mortgage Corporation
Second Amended and Restated Incentive Bonus Plan and announcing the issuance of stock option
grants to the Companys directors and employees.
 -32-




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##### Table of Contents



SIGNATURES
  CAPSTEAD MORTGAGE CORPORATIONRegistrantDate: May 5, 2006
    
    By:
    
    /s/ ANDREW F. JACOBSAndrew F. JacobsPresident and Chief Executive OfficerDate: May 5, 2006
    
    By:
    
    /s/ PHILLIP A. REINSCHPhillip A. ReinschSenior Vice President andChief Financial Officer
 -33-