##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended: June 30, 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
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)8401 North Central Expressway, Suite 800, Dallas, TX
    
    75225(Address of principal executive offices)
    
    (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)
    
    19,043,902 as of August 1, 2006




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##### 



CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2006
 INDEX
 PagePART I.  FINANCIAL INFORMATIONITEM 1. Financial StatementsConsolidated Balance Sheets  June 30, 2006 and December 31, 2005
    
    
    3Consolidated Statements of  Operations Quarter and Six Months Ended June 30, 2006 and 2005
    
    
    4Consolidated Statements of Cash Flows  Six Months Ended June 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
    
    
    31ITEM 4. Controls and Procedures
    
    
    31PART II.  OTHER INFORMATIONITEM 6. Exhibits and Reports on Form 8-K
    
    
    31SIGNATURES
    
    
    32Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock DividendsCertification Pursuant to Section 302(a)Certification Pursuant 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)
 June 30, 2006
    
    
    December 31, 2005(unaudited)
    
    
    (NOTE 2)Assets:Mortgage securities and similar investments
($4.6 billion pledged under repurchase arrangements)
    
    $
    4,787,645
    
    
    $
    4,368,025Investments in unconsolidated affiliates
    
    
    18,645
    
    
    
    9,246Receivables and other assets
    
    
    67,331
    
    
    
    53,040Cash and cash equivalents
    
    
    
    
    
    
    33,937$
    4,873,621
    
    
    $
    4,464,248Liabilities:Repurchase arrangements and similar borrowings
    
    $
    4,462,835
    
    
    $
    4,023,686Unsecured borrowings
    
    
    77,321
    
    
    
    77,321Liabilities of discontinued operation
    
    
    
    
    
    
    2,884Common stock dividend payable
    
    
    381
    
    
    
    381Accounts payable and accrued expenses
    
    
    11,906
    
    
    
    15,1274,552,443
    
    
    
    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
June 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
June 30, 2006 and December 31, 2005
($180,025 aggregate liquidation preference)
    
    
    176,705
    
    
    
    176,705Common stock  $0.01 par value; 100,000 shares authorized:19,028 and 19,043 shares issued and outstanding at
June 30, 2006 and December 31, 2005, respectively
    
    
    190
    
    
    
    190Paid-in capital
    
    
    505,266
    
    
    
    512,933Accumulated deficit
    
    
    (352,803
    )
    
    
    (352,803
    )Accumulated other comprehensive income (loss)
    
    
    (11,008
    )
    
    
    4,996321,178
    
    
    
    344,849$
    4,873,621
    
    
    $
    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
    
    
    Six Months EndedJune 30
    
    
    June 302006
    
    
    2005
    
    
    2006
    
    
    2005Mortgage securities and similar investments:Interest income
    
    $
    57,349
    
    
    $
    30,589
    
    
    $
    110,275
    
    
    $
    59,112Interest expense
    
    
    (54,685
    )
    
    
    (23,794
    )
    
    
    (102,228
    )
    
    
    (43,827
    )2,664
    
    
    
    6,795
    
    
    
    8,047
    
    
    
    15,285Other revenue (expense):Other revenue
    
    
    200
    
    
    
    215
    
    
    
    366
    
    
    
    411Interest expense on unsecured borrowings
    
    
    (1,621
    )
    
    
    
    
    
    
    (3,208
    )
    
    
    Other operating expense
    
    
    (1,576
    )
    
    
    (1,482
    )
    
    
    (3,249
    )
    
    
    (3,012
    )(2,997
    )
    
    
    (1,267
    )
    
    
    (6,091
    )
    
    
    (2,601
    )Income (loss) before equity in earnings of
unconsolidated affiliates and discontinued
operation
    
    
    (333
    )
    
    
    5,528
    
    
    
    1,956
    
    
    
    12,684Equity in earnings of unconsolidated affiliates
    
    
    608
    
    
    
    
    
    
    
    1,030
    
    
    
    Income from continuing operations
    
    
    275
    
    
    
    5,528
    
    
    
    2,986
    
    
    
    12,684Income from discontinued operation
    
    
    
    
    
    
    462
    
    
    
    
    
    
    
    908Net income
    
    $
    275
    
    
    $
    5,990
    
    
    $
    2,986
    
    
    $
    13,592Net income available (loss attributable) to
common stockholders:Net income
    
    $
    275
    
    
    $
    5,990
    
    
    $
    2,986
    
    
    $
    13,592Less cash dividends paid on preferred stock
    
    
    (5,064
    )
    
    
    (5,064
    )
    
    
    (10,128
    )
    
    
    (10,128
    )$
    (4,789
    )
    
    $
    926
    
    
    $
    (7,142
    )
    
    $
    3,464Basic and diluted earnings (loss) per common
share:Income (loss) from continuing operations
    
    $
    (0.25
    )
    
    $
    0.03
    
    
    $
    (0.38
    )
    
    $
    0.13Income from discontinued operation
    
    
    
    
    
    
    0.02
    
    
    
    
    
    
    
    0.05$
    (0.25
    )
    
    $
    0.05
    
    
    $
    (0.38
    )
    
    $
    0.18Cash dividends declared per share:Common
    
    $
    0.020
    
    
    $
    0.100
    
    
    $
    0.040
    
    
    $
    0.280Series A Preferred
    
    
    0.400
    
    
    
    0.400
    
    
    
    0.800
    
    
    
    0.800Series B Preferred
    
    
    0.315
    
    
    
    0.315
    
    
    
    0.630
    
    
    
    0.630
 See accompanying notes to consolidated financial statements
 -4-




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

(unaudited)
 Six Months Ended June 302006
    
    
    2005Operating activities:Net income
    
    $
    2,986
    
    
    $
    13,592Noncash items:Amortization of investment premiums
    
    
    11,737
    
    
    
    10,131Depreciation and other amortization
    
    
    50
    
    
    
    60Stock-based compensation
    
    
    244
    
    
    
    77Undistributed earnings of unconsolidated affiliates
    
    
    (181
    )
    
    
    Net change in receivables, other assets, accounts payable and
accrued expenses
    
    
    (13,418
    )
    
    
    (2,860
    )Net cash provided by operating activities of continuing operations
    
    
    1,418
    
    
    
    21,000Net cash provided by operating activities of discontinued operation
    
    
    
    
    
    
    1,375Net cash provided by operating activities
    
    
    1,418
    
    
    
    22,375Investing activities:Purchases of mortgage securities and similar investments
    
    
    (1,306,819
    )
    
    
    (710,966
    )Principal collections on mortgage securities and similar investments
    
    
    855,293
    
    
    
    625,374Investments in unconsolidated affiliate  commercial real estate
loan limited partnership
    
    
    (9,218
    )
    
    
    Net cash used in investing activities of continuing operations
    
    
    (460,744
    )
    
    
    (85,592
    )Net cash used in investing activities of discontinued operation
    
    
    (2,884
    )
    
    
    Net cash used in investing activities
    
    
    (463,628
    )
    
    
    (85,592
    )Financing activities:Net increase (decrease) in repurchase arrangements and similar
borrowings
    
    
    439,170
    
    
    
    8,135Capital stock transactions
    
    
    (8
    )
    
    
    26Dividends paid
    
    
    (10,889
    )
    
    
    (17,676
    )Net cash provided by (used in) financing activities of continuing
operations
    
    
    428,273
    
    
    
    (9,515
    )Net cash used in financing activities of discontinued operation
    
    
    
    
    
    
    (117
    )Net cash provided by (used in) financing activities
    
    
    428,273
    
    
    
    (9,632
    )Net change in cash and cash equivalents
    
    
    (33,937
    )
    
    
    (72,849
    )Cash and cash equivalents at beginning of period
    
    
    33,937
    
    
    
    73,030Cash and cash equivalents at end of period
    
    $
    
    
    
    $
    181
 See accompanying notes to consolidated financial statements.
 -5-




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##### Table of Contents



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




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##### Table of Contents



Quarter Ended
    
    
    Six Months EndedJune 30
    
    
    June 302006
    
    
    2005
    
    
    2006
    
    
    2005Numerators for basic earnings (loss)
per common share:Income from continuing operations
    
    $
    275
    
    
    $
    5,528
    
    
    $
    2,986
    
    
    $
    12,684Less Series A and B preferred share dividends
    
    
    (5,064
    )
    
    
    (5,064
    )
    
    
    (10,128
    )
    
    
    (10,128
    )Income from continuing operations available
(loss attributable) to common stockholders
    
    
    (4,789
    )
    
    
    464
    
    
    
    (7,142
    )
    
    
    2,556Income from discontinued operation
    
    
    
    
    
    
    462
    
    
    
    
    
    
    
    908$
    (4,789
    )
    
    $
    926
    
    
    $
    (7,142
    )
    
    $
    3,464Weighted average common shares outstanding
    
    
    18,894
    
    
    
    18,869
    
    
    
    18,883
    
    
    
    18,865Basic earnings (loss) per common share:Income (loss) from continuing operations
    
    $
    (0.25
    )
    
    $
    0.03
    
    
    $
    (0.38
    )
    
    $
    0.13Income from discontinued operation
    
    
    
    
    
    
    0.02
    
    
    
    
    
    
    
    0.05$
    (0.25
    )
    
    $
    0.05
    
    
    $
    (0.38
    )
    
    $
    0.18Numerators for diluted earnings (loss)
per common share:Income from continuing operations
    
    $
    275
    
    
    $
    5,528
    
    
    $
    2,986
    
    
    $
    12,684Less dividends on antidilutive convertible
preferred shares
    
    
    (5,064
    )
    
    
    (5,064
    )
    
    
    (10,128
    )
    
    
    (10,128
    )Income from continuing operations available
(loss attributable) to common stockholders
    
    
    (4,789
    )
    
    
    464
    
    
    
    (7,142
    )
    
    
    2,556Income from discontinued operation
    
    
    
    
    
    
    462
    
    
    
    
    
    
    
    908$
    (4,789
    )
    
    $
    926
    
    
    $
    (7,142
    )
    
    $
    3,464Denominator for diluted earnings (loss)
per common share:Weighted average common shares outstanding
    
    
    18,894
    
    
    
    18,869
    
    
    
    18,883
    
    
    
    18,865Net effect of dilutive stock options
    
    
    
    
    
    
    39
    
    
    
    
    
    
    
    40Net effect of dilutive convertible preferred shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,894
    
    
    
    18,908
    
    
    
    18,883
    
    
    
    18,905Diluted earnings (loss) per common share:Income (loss) from continuing operations
    
    $
    (0.25
    )
    
    $
    0.03
    
    
    $
    (0.38
    )
    
    $
    0.13Income from discontinued operation
    
    
    
    
    
    
    0.02
    
    
    
    
    
    
    
    0.05$
    (0.25
    )
    
    $
    0.05
    
    
    $
    (0.38
    )
    
    $
    0.18Antidilutive securities excluded from the calculation
of diluted earnings (loss) per common share:Nonvested stock grants and shares issuable
under stock option awards
    
    
    948
    
    
    
    338
    
    
    
    948
    
    
    
    318Series 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
    
    
    
    
    
    
    AverageBalance
    
    
    Premiums
    
    
    Basis
    
    
    Amount(a)
    
    
    WAC(b)
    
    
    Yield (b)June 30, 2006Agency Securities:Fannie Mae/Freddie Mac:Fixed-rate
    
    $
    20,031
    
    
    $
    68
    
    
    $
    20,099
    
    
    $
    20,128
    
    
    
    6.62
    %
    
    
    6.26
    %ARMs
    
    
    3,784,735
    
    
    
    56,512
    
    
    
    3,841,247
    
    
    
    3,830,664
    
    
    
    5.65
    
    
    
    4.75Ginnie Mae ARMs
    
    
    870,031
    
    
    
    2,853
    
    
    
    872,884
    
    
    
    871,943
    
    
    
    4.76
    
    
    
    4.754,674,797
    
    
    
    59,433
    
    
    
    4,734,230
    
    
    
    4,722,735
    
    
    
    5.49
    
    
    
    4.75Non-agency Securities:Fixed-rate
    
    
    21,339
    
    
    
    73
    
    
    
    21,412
    
    
    
    21,456
    
    
    
    7.15
    
    
    
    6.55ARMs
    
    
    36,232
    
    
    
    358
    
    
    
    36,590
    
    
    
    36,851
    
    
    
    6.37
    
    
    
    5.7957,571
    
    
    
    431
    
    
    
    58,002
    
    
    
    58,307
    
    
    
    6.66
    
    
    
    6.07Collateral for structured
financings
    
    
    6,502
    
    
    
    101
    
    
    
    6,603
    
    
    
    6,603
    
    
    
    8.02
    
    
    
    6.87$
    4,738,870
    
    
    $
    59,965
    
    
    $
    4,798,835
    
    
    $
    4,787,645
    
    
    
    5.51
    
    
    
    4.77December 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  adjustable-rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    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)
    
    WAC, or 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
 Mortgage securities and similar investments
 -10-




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##### Table of Contents



June 30, 2006
    
    
    December 31, 2005Borrowings
    
    
    Average
    
    
    Borrowings
    
    
    AverageOutstanding
    
    
    Rate
    
    
    Outstanding
    
    
    RateBorrowings with maturities of 30 days or less:Agency Securities
    
    $
    2,348,052
    
    
    
    5.25
    %
    
    $
    3,133,090
    
    
    
    4.23
    %Non-agency Securities
    
    
    53,840
    
    
    
    5.84
    
    
    
    63,734
    
    
    
    4.882,401,892
    
    
    
    5.26
    
    
    
    3,196,824
    
    
    
    4.24Borrowings with maturities greater than 30 days:Agency Securities (31 to 90 days)*
    
    
    1,209,553
    
    
    
    5.32
    
    
    
    25,000
    
    
    
    3.25Agency Securities (91 to 360 days)
    
    
    240,224
    
    
    
    4.13
    
    
    
    331,907
    
    
    
    2.79Agency Securities (greater than 360 days)
    
    
    604,563
    
    
    
    4.81
    
    
    
    460,857
    
    
    
    4.502,054,340
    
    
    
    5.03
    
    
    
    817,764
    
    
    
    3.77Collateral for structured financings
    
    
    6,603
    
    
    
    7.21
    
    
    
    9,098
    
    
    
    7.95$
    4,462,835
    
    
    
    5.16
    
    
    $
    4,023,686
    
    
    
    4.15
 
 *
    
    Includes $893 million of repurchase arrangements with 32 to 34 day maturities as of June 30, 2006. Repurchase arrangements and similar borrowings
 NOTE 8 3⁄4 UNSECURED BORROWINGS
 Unsecured borrowings
 Borrowings
    
    
    AverageOutstanding
    
    
    RateJunior subordinated notes:Capstead Mortgage Trust I
    
    $
    36,083
    
    
    
    8.31
    %Capstead Mortgage Trust II
    
    
    41,238
    
    
    
    8.45$
    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
  June 30, 2006
    
    
    December 31, 2005Fair
    
    
    Unrealized
    
    
    Fair
    
    
    UnrealizedValue
    
    
    Loss
    
    
    Value
    
    
    LossSecurities in an unrealized loss position:One year or greater
    
    $
    659,008
    
    
    $
    9,659
    
    
    $
    472,584
    
    
    $
    6,313Less than one year
    
    
    2,063,052
    
    
    
    16,837
    
    
    
    1,431,465
    
    
    
    8,611$
    2,722,060
    
    
    $
    26,496
    
    
    $
    1,904,049
    
    
    $
    14,924
  Gross
    
    
    GrossUnrealized
    
    
    Unrealized
    
    
    FairBasis
    
    
    Gains
    
    
    Losses
    
    
    ValueAs of June 30, 2006Agency Securities:Fixed-rate
    
    $
    386
    
    
    $
    29
    
    
    $
    
    
    
    $
    415ARMs
    
    
    4,714,131
    
    
    
    14,842
    
    
    
    26,366
    
    
    
    4,702,6074,714,517
    
    
    
    14,871
    
    
    
    26,366
    
    
    
    4,703,022Non-agency Securities
    
    
    29,677
    
    
    
    331
    
    
    
    26
    
    
    
    29,982$
    4,744,194
    
    
    $
    15,202
    
    
    $
    26,392
    
    
    $
    4,733,004As 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-




---



##### Table of Contents



Gross
    
    
    GrossUnrealized
    
    
    Unrealized
    
    
    FairBasis
    
    
    Gains
    
    
    Losses
    
    
    ValueAs of June 30, 2006Collateral released from structured
financings:Agency Securities
    
    $
    19,713
    
    
    $
    209
    
    
    $
    11
    
    
    $
    19,911Non-agency Securities
    
    
    28,325
    
    
    
    314
    
    
    
    93
    
    
    
    28,546Collateral for structured financings
    
    
    6,603
    
    
    
    
    
    
    
    
    
    
    
    6,603$
    54,641
    
    
    $
    523
    
    
    $
    104
    
    
    $
    55,060As 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
    
    
    Six Months EndedJune 30
    
    
    June 302006
    
    
    2005
    
    
    2006
    
    
    2005Net income
    
    $
    275
    
    
    $
    5,990
    
    
    $
    2,986
    
    
    $
    13,592Other comprehensive income (loss):Amounts related to cash flow hedges:Reclassification adjustment for amounts
included in net income
    
    
    (14
    )
    
    
    (18
    )
    
    
    (30
    )
    
    
    (52
    )Amounts related to discontinued operation
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    (7
    )Amounts related to securities held
available-for-sale:Change in valuation of mortgage securities
held available-for-sale
    
    
    (8,456
    )
    
    
    2,916
    
    
    
    (15,974
    )
    
    
    (2,205
    )Other comprehensive income (loss)
    
    
    (8,470
    )
    
    
    2,904
    
    
    
    (16,004
    )
    
    
    (2,264
    )Comprehensive income (loss)
    
    $
    (8,195
    )
    
    $
    8,894
    
    
    $
    (13,018
    )
    
    $
    11,328
 NOTE 11 3⁄4 LONG-TERM INCENTIVE AND OTHER PLANS
  -13-




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##### Table of Contents



Nonvested Stock Grant ActivityWeighted AverageNumber of
    
    
    Grant DateShares
    
    
    Fair ValueAs of December 31, 2005
    
    
    172,600
    
    
    $
    7.86Grants
    
    
    
    
    
    
    Forfeitures
    
    
    (17,800
    )
    
    
    7.82Vested
    
    
    (42,750
    )
    
    
    7.86As of June 30, 2006
    
    
    112,050
    
    
    
    7.87
  Stock Option Grant ActivityNumber of
    
    
    Weighted AverageShares
    
    
    Exercise PriceAs of December 31, 2005 (419,782 exercisable at average
price: $21.87)
    
    
    777,669
    
    
    $
    15.33Grants (average fair value: $0.80)
    
    
    208,000
    
    
    
    7.58Forfeitures
    
    
    (73,750
    )
    
    
    7.73Expirations
    
    
    (76,348
    )
    
    
    22.86Exercises
    
    
    
    
    
    
    As of June 30, 2006 (465,071 exercisable at average price: $17.89)
    
    
    835,571
    
    
    
    13.38
 
 *
    
    Option grants were valued with average expected terms of four years, volatility
factors of 31%, dividend yields of 10% and risk-free rates of 4.88%.   -14-




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##### Table of Contents



NOTE 12 3⁄4 NET INTEREST INCOME ANALYSIS
 Unsecured
borrowings
 Quarter Ended June 302006
    
    
    2005Average
    
    
    
    
    
    
    AverageAmount
    
    
    Rate
    
    
    Amount
    
    
    RateInterest income
    
    $
    57,349
    
    
    
    4.77
    %
    
    $
    30,589
    
    
    
    3.53
    %Interest expense
    
    
    (54,685
    )
    
    
    4.83
    
    
    
    (23,794
    )
    
    
    2.92$
    2,664
    
    
    
    (0.06
    )
    
    $
    6,795
    
    
    
    0.61
 Six Months Ended June 302006
    
    
    2005Average
    
    
    
    
    
    
    AverageAmount
    
    
    Rate
    
    
    Amount
    
    
    RateInterest income
    
    $
    110,275
    
    
    
    4.65
    %
    
    $
    59,112
    
    
    
    3.43
    %Interest expense
    
    
    (102,228
    )
    
    
    4.61
    
    
    
    (43,827
    )
    
    
    2.72$
    8,047
    
    
    
    0.04
    
    
    $
    15,285
    
    
    
    0.71
  Quarter Ended June 30, 2006Rate *
    
    
    Volume *
    
    
    Total *Total interest income
    
    $
    12,719
    
    
    $
    14,041
    
    
    $
    26,760Total interest expense
    
    
    19,121
    
    
    
    11,770
    
    
    
    30,891$
    (6,402
    )
    
    $
    2,271
    
    
    $
    (4,131
    )
 Six Months Ended June 30, 2006Rate *
    
    
    Volume *
    
    
    Total *Total interest income
    
    $
    24,829
    
    
    $
    26,334
    
    
    $
    51,163Total interest expense
    
    
    37,678
    
    
    
    20,723
    
    
    
    58,401$
    (12,849
    )
    
    $
    5,611
    
    
    $
    (7,238
    )
 
 *
    
    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
     Risk Factors and Critical Accounting Policies
  -16-




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##### Table of Contents



Accounting for Acquisitions of Mortgage Securities Seller-Financed using Repurchase Arrangements
  Mortgage Securities and Similar Investments
  
 -17-




---



##### Table of Contents



Projected
    
    
    Lifetime2ndQuarter Average
    
    
    As of June 30, 2006
    
    
    3rd Quarter
    
    
    RunoffBasis(a)
    
    
    Yield/Cost
    
    
    Runoff
    
    
    Premiums
    
    
    Basis(a)
    
    
    Yield/Cost(b)
    
    
    AssumptionsAgency Securities:Fannie Mae/Freddie Mac:Fixed-rate
    
    $
    21,195
    
    
    
    6.26
    %
    
    
    30
    %
    
    $
    68
    
    
    $
    20,099
    
    
    
    6.40
    %
    
    
    38
    %ARMs
    
    
    3,826,930
    
    
    
    4.75
    
    
    
    32
    
    
    
    56,512
    
    
    
    3,841,247
    
    
    
    5.10
    
    
    
    32Ginnie Mae ARMs
    
    
    887,618
    
    
    
    4.75
    
    
    
    32
    
    
    
    2,853
    
    
    
    872,884
    
    
    
    4.79
    
    
    
    294,735,743
    
    
    
    4.75
    
    
    
    32
    
    
    
    59,433
    
    
    
    4,734,230
    
    
    
    5.05
    
    
    
    31Non-agency Securities:Fixed-rate
    
    
    22,726
    
    
    
    6.55
    
    
    
    36
    
    
    
    73
    
    
    
    21,412
    
    
    
    6.85
    
    
    
    37ARMs
    
    
    38,183
    
    
    
    5.79
    
    
    
    25
    
    
    
    358
    
    
    
    36,590
    
    
    
    6.29
    
    
    
    3860,909
    
    
    
    6.07
    
    
    
    30
    
    
    
    431
    
    
    
    58,002
    
    
    
    6.50
    
    
    
    38Collateral for
structured
financings
    
    
    7,196
    
    
    
    6.87
    
    
    
    45
    
    
    
    101
    
    
    
    6,603
    
    
    
    7.24
    
    
    
    304,803,848
    
    
    
    4.77
    
    
    
    32
    
    
    $
    59,965
    
    
    
    4,798,835
    
    
    
    5.06
    
    
    
    31Related borrowings:30-day LIBOR
    
    
    3,494,207
    
    
    
    4.97
    
    
    
    
    
    
    
    
    
    
    
    3,611,445
    
    
    
    5.30>30-day LIBOR
    
    
    970,906
    
    
    
    4.34
    
    
    
    
    
    
    
    
    
    
    
    844,787
    
    
    
    4.65Structured financings
    
    
    7,196
    
    
    
    6.87
    
    
    
    
    
    
    
    
    
    
    
    6,603
    
    
    
    7.244,472,309
    
    
    
    4.83
    
    
    
    
    
    
    
    
    
    
    
    4,462,835
    
    
    
    5.17Capital employed/
financing spread
    
    $
    331,539
    
    
    
    (0.06)
    
    
    
    
    
    
    
    
    
    
    $
    336,000
    
    
    
    (0.11
    )Return on assets (c)
    
    
    
    
    
    
    0.22
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.13
 
 (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 July 20, 2006, the date second quarter
earnings were released. 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 based on 30-day London Interbank offered Rate (LIBOR) reflect the 25 basis point
increase in the federal funds rate to 5.25% at the June 29, 2006 Federal Reserve meeting with
no additional increases 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
September 30, 2006 only), are as follows: Ending
    
    Portfolio AveragesFederal
    
    
    
    
    
    Borrowing
    
    Financing
    
    RunoffFunds Rate
    
    Yields
    
    Rates
    
    Spreads *
    
    RatesThird Quarter 2006
    
    
    5.25
    %
    
    
    5.06
    %
    
    
    5.17
    %
    
    
    (0.11
    )%
    
    
    31
    %Fourth Quarter 2006
    
    
    5.25
    
    
    
    5.37
    
    
    
    5.20
    
    
    
    0.17
    
    
    
    29First Quarter 2007
    
    
    5.25
    
    
    
    5.60
    
    
    
    5.20
    
    
    
    0.40
    
    
    
    27Second Quarter 2007
    
    
    5.25
    
    
    
    5.72
    
    
    
    5.24
    
    
    
    0.48
    
    
    
    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.
 -18-




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##### Table of Contents



Investment in Redtail Capital
  -19-




---



##### Table of Contents



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




---



##### Table of Contents



Related
    
    
    Capital
    
    
    PotentialInvestments(a)
    
    
    Borrowings
    
    
    Employed(a)
    
    
    Liquidity(a)Mortgage securities and similar
investments:Agency Securities
    
    $
    4,722,735
    
    
    $
    4,402,392
    
    
    $
    320,343
    
    
    $
    184,756Non-agency Securities
    
    
    58,307
    
    
    
    53,840
    
    
    
    4,467
    
    
    
    (268
    )Collateral for structured financings
    
    
    6,603
    
    
    
    6,603
    
    
    
    
    
    
    
    4,787,645
    
    
    
    4,462,835
    
    
    
    324,810
    
    
    
    184,488Investment in Redtail Capital
    
    
    16,304
    
    
    
    
    
    
    
    16,304
    
    
    
    3,174$
    4,803,949
    
    
    $
    4,462,835
    
    
    
    341,114
    
    
    
    187,662Other assets, net of other liabilities
    
    
    
    
    
    
    
    
    
    
    55,425
    
    
    
    Second quarter common dividend
    
    
    
    
    
    
    
    
    
    
    (381
    )
    
    
    (381
    )(b)$
    396,158
    
    
    $
    187,281Balances 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 second quarter 2006 common dividend was declared June 15, 2006 and paid July 20, 2006
to stockholders of record as of June 30, 2006.  -21-




---



##### Table of Contents



RESULTS OF OPERATIONS
  Quarter Ended
    
    Six Months EndedJune 30
    
    June 302006
    
    2005
    
    2006
    
    2005Income statement data:Mortgage securities and similar investments:Agency Securities
    
    $
    2,525
    
    
    $
    6,116
    
    
    $
    7,728
    
    
    $
    13,865Non-agency Securities
    
    
    139
    
    
    
    475
    
    
    
    319
    
    
    
    996CMBS and other commercial loans
    
    
    
    
    
    
    144
    
    
    
    
    
    
    
    280Collateral for structured financings
    
    
    
    
    
    
    60
    
    
    
    
    
    
    
    1442,664
    
    
    
    6,795
    
    
    
    8,047
    
    
    
    15,285Other revenue (expense):Other revenue
    
    
    200
    
    
    
    215
    
    
    
    366
    
    
    
    411Interest on unsecured borrowings
    
    
    (1,621
    )
    
    
    
    
    
    
    (3,208
    )
    
    
    Other operating expense
    
    
    (1,576
    )
    
    
    (1,482
    )
    
    
    (3,249
    )
    
    
    (3,012
    )(333
    )
    
    
    5,528
    
    
    
    1,956
    
    
    
    12,684Equity in earnings of unconsolidated affiliates
    
    
    608
    
    
    
    
    
    
    
    1,030
    
    
    
    Income from continuing operations
    
    
    275
    
    
    
    5,528
    
    
    
    2,986
    
    
    
    12,684Income from discontinued operation
    
    
    
    
    
    
    462
    
    
    
    
    
    
    
    908Net income
    
    $
    275
    
    
    $
    5,990
    
    
    $
    2,986
    
    
    $
    13,592Diluted earnings (loss) per common share:Income (loss) from continuing operations
    
    $
    (0.25
    )
    
    $
    0.03
    
    
    $
    (0.38
    )
    
    $
    0.13Income from discontinued operation
    
    
    
    
    
    
    0.02
    
    
    
    
    
    
    
    0.05$
    (0.25
    )
    
    $
    0.05
    
    
    $
    (0.38
    )
    
    $
    0.18Key portfolio statistics:Average yields:Agency Securities
    
    
    4.75
    %
    
    
    3.46
    %
    
    
    4.63
    %
    
    
    3.38
    %Non-agency Securities
    
    
    6.07
    
    
    
    5.08
    
    
    
    5.90
    
    
    
    4.89CMBS and other commercial loans
    
    
    
    
    
    
    4.08
    
    
    
    
    
    
    
    3.85Collateral for structured financings
    
    
    6.87
    
    
    
    5.76
    
    
    
    7.13
    
    
    
    4.13Total average yields
    
    
    4.77
    
    
    
    3.53
    
    
    
    4.65
    
    
    
    3.43Average related borrowing rates
    
    
    4.83
    
    
    
    2.92
    
    
    
    4.61
    
    
    
    2.72Average financing spreads
    
    
    (0.06
    )
    
    
    0.61
    
    
    
    0.04
    
    
    
    0.71Average portfolio balances:Agency Securities
    
    $
    4,736
    
    
    $
    3,310
    
    
    $
    4,671
    
    
    $
    3,276Non-agency Securities
    
    
    61
    
    
    
    79
    
    
    
    63
    
    
    
    82CMBS and other commercial loans
    
    
    
    
    
    
    51
    
    
    
    
    
    
    
    51Collateral for structured financings
    
    
    7
    
    
    
    26
    
    
    
    8
    
    
    
    354,804
    
    
    
    3,466
    
    
    
    4,742
    
    
    
    3,444Related average borrowings
    
    
    4,472
    
    
    
    3,219
    
    
    
    4,406
    
    
    
    3,201Average capital deployed
    
    $
    332
    
    
    $
    247
    
    
    $
    336
    
    
    $
    243Average portfolio runoff rates:Agency Securities
    
    
    32
    %
    
    
    33
    %
    
    
    31
    %
    
    
    30
    %Total
    
    
    32
    
    
    
    33
    
    
    
    31
    
    
    
    28
 -22-




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##### Table of Contents



-23-




---



##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES
     -24-




---



##### Table of Contents



RISK FACTORS
 General Discussion of Effects of Interest Rate Changes
  Fully
    
    Average
    
    Average
    
    Average
    
    MonthsIndexed
    
    Net
    
    Periodic
    
    Lifetime
    
    ToARM Type
    
    Basis *
    
    WAC
    
    WAC
    
    Margins
    
    Caps
    
    Caps
    
    RollCurrent-reset ARMs:Agency Securities:Fannie
Mae/Freddie Mac
    
    $
    2,720,346
    
    
    
    5.58
    %
    
    
    7.03
    %
    
    
    1.91
    %
    
    
    3.38
    %
    
    
    10.97
    %
    
    
    6.4Ginnie Mae
    
    
    872,884
    
    
    
    4.76
    
    
    
    6.78
    
    
    
    1.53
    
    
    
    1.00
    
    
    
    9.84
    
    
    
    5.7Non-agency Securities
    
    
    36,590
    
    
    
    6.37
    
    
    
    7.70
    
    
    
    2.11
    
    
    
    1.70
    
    
    
    11.34
    
    
    
    6.13,629,820
    
    
    
    5.39
    
    
    
    6.98
    
    
    
    1.82
    
    
    
    2.79
    
    
    
    10.70
    
    
    
    6.2Longer-to-reset ARMs:Agency Securities:Fannie
Mae/Freddie Mac
    
    
    1,120,901
    
    
    
    5.80
    
    
    
    7.42
    
    
    
    1.87
    
    
    
    4.19
    
    
    
    11.66
    
    
    
    41.4$
    4,750,721
    
    
    
    5.49
    
    
    
    7.08
    
    
    
    1.83
    
    
    
    3.12
    
    
    
    10.93
    
    
    
    14.5
 
 *
    
    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



30-day
    
    
    10-year 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
    
    
    
    
    
    
       Up
    
    
    
    
    
    
    Up10-year U.S. Treasury rate
    
    
    
    
    
    
    
    
    
    
    1.00
    %
    
    Flat
    
    
    
    1.00
    %
    
    Flat
    
    
    
    1.00
    %Projected 12-month
earnings change:June 30, 2006**
    
    
    5.33
    %
    
    
    5.14
    %
    
    $
    17,440
    
    
    $
    19,610
    
    
    $
    (4,495
    )
    
    $
    (24,918
    )
    
    $
    (23,555
    )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 June 30, 2006 primarily reflects the increased size of
the Companys mortgage securities and similar investments portfolio. Risks Associated With Credit-Sensitive Investments
   
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Tax Status
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Investment Company Act of 1940
   CRITICAL ACCOUNTING POLICIES
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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
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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 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.Current Report on Form 8-K dated May 18, 2006 to file a Capstead Mortgage Corporation
presentation to investment community.Current Report on Form 8-K dated June 6, 2006 to file a Capstead Mortgage Corporation
presentation to investment community.
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SIGNATURES
  CAPSTEAD MORTGAGE CORPORATIONRegistrantDate:  August 1, 2006
    By:
    /s/ ANDREW F. JACOBSAndrew F. JacobsPresident and Chief Executive OfficerDate:  August 1, 2006
    By:
    /s/ PHILLIP A. REINSCHPhillip A. ReinschExecutive Vice President and
Chief Financial Officer -32-