e10vk

-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JgIYmp5H1Yzb7qBbHf1xEmqVsmIAFhPX4XTWhypS6OmG+iFmUrW7TL65Np6m+Dr0 5RHdjB+FdYHlgD26Rk8o7A== 0000950134-04-003062.txt : 20040308 0000950134-04-003062.hdr.sgml : 20040308 20040308144452 ACCESSION NUMBER: 0000950134-04-003062 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040308 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPSTEAD MORTGAGE CORP CENTRAL INDEX KEY: 0000766701 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 752027937 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-08896 FILM NUMBER: 04654526 BUSINESS ADDRESS: STREET 1: 8401 NORTH CENTRAL EXPRESSWAY STREET 2: STE 800 CITY: DALLAS STATE: TX ZIP: 75225 BUSINESS PHONE: 2148742323 MAIL ADDRESS: STREET 1: 8401 NORTH CENTRAL EXPRESSWAY STREET 2: STE 800 CITY: DALLAS STATE: TX ZIP: 75225 FORMER COMPANY: FORMER CONFORMED NAME: LOMAS MORTGAGE CORP DATE OF NAME CHANGE: 19891105 10-K 1 d13093e10vk.htm FORM 10-K e10vk

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K


þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended: December 31, 2003


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: 1-8896

CAPSTEAD MORTGAGE CORPORATION

(Exact name of Registrant as specified in its Charter)


Maryland		75-2027937
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

8401 North Central Expressway, Suite 800, Dallas, TX		75225
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (214) 874-2323

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class		Name of Exchange on Which Registered

Common Stock ($0.01 par value)		New York Stock Exchange
$1.60 Cumulative Preferred Stock, Series A ($0.10 par value)		New York Stock Exchange
$1.26 Cumulative Convertible Preferred Stock, Series B ($0.10 par value)		New York Stock Exchange

Indicate by check mark whether the Registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K: o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 126-2 of the Act). YES þ NO o

At June 30, 2003 the aggregate market value of the voting common stock held by nonaffiliates was $156,187,000.

Number of shares of Common Stock outstanding at March 5, 2004: 14,470,851

DOCUMENTS INCORPORATED BY REFERENCE:

(1) Portions of the Registrant’s Annual Report to Stockholders for the year ended December 31, 2003 are incorporated by reference into Parts I, II and IV.

(2) Portions of the Registrant’s definitive Proxy Statement, issued in connection with the 2004 Annual Meeting of Stockholders of the Registrant, are incorporated by reference into Part III.

CAPSTEAD MORTGAGE CORPORATION

2003 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS


		Page
PART I
ITEM 1.	Business		1
ITEM 2.	Properties		3
ITEM 3.	Legal Proceedings		3
ITEM 4.	Submission of Matters to a Vote of Security		4
PART II
ITEM 5.	Market for Registrant’s Common Equity and Related Stockholder Matters		4
ITEM 6.	Selected Financial Data		4
ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		4
ITEM 7A.	Quantitative and Qualitative Disclosures About Market Risks		4
ITEM 8.	Financial Statements and Supplementary Data		4
ITEM 9.	Changes In and Disagreements With Accountants on Accounting and Financial Disclosure		4
ITEM 9A.	Controls and Procedures		4
PART III
ITEM 10.	Directors and Executive Officers of the Registrant		5
ITEM 11.	Executive Compensation		5
ITEM 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		5
ITEM 13.	Certain Relationships and Related Transactions		5
ITEM 14.	Principal Accountant Fees and Services		5
PART IV
ITEM 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K		6
SIGNATURES			8
Computation of Ratio of Earnings to Fixed Charges
2003 Annual Report to Stockholders
List of Subsidiaries of the Company
Consent of Ernst & Young LLP, Independent Auditors
Certification Pursuant to Section 302(a)
Certification Pursuant to Section 302(a)
Certification Pursuant to Section 906

PART I

ITEM 1. BUSINESS.

Capstead Mortgage Corporation (“Capstead,” the “Company” or the “Registrant”) was incorporated on April 15, 1985 in Maryland and commenced operations in September 1985. Capstead operates as a real estate investment trust (“REIT”) earning income from investing in real estate-related assets on a leveraged basis and other investment strategies. These investments currently include, but are not limited to, financial assets, specifically residential adjustable-rate mortgage securities (“ARM”) issued by government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae (“Agency Securities”). Capstead has also made limited investments in credit-sensitive commercial mortgage assets including the direct ownership of real estate. Management believes that such investments, when available at attractive prices and combined with the prudent use of leverage, can provide attractive risk-adjusted returns over the long term with relatively low sensitivity to changes in interest rates.

The earning capacity of Capstead’s financial asset portfolios is influenced by the overall size and composition of the portfolios, the relationship between short- and long-term interest rates (the “yield curve”) and the extent the Company continues to invest its liquidity in these portfolios. Although having moderated considerably during the fourth quarter of 2003 and into early 2004, runoff caused by mortgage prepayments remains a significant challenge to earnings generated by these portfolios. To the extent the proceeds of mortgage prepayments and other maturities are not reinvested or cannot be reinvested at a rate of return on invested capital at least equal to the return earned on previous investments, earnings and common dividends may decline.

For further discussion of the Company’s business and financial condition, see the Registrant’s Annual Report to Stockholders for the year ended December 31, 2003 on pages 29 through 48, which is incorporated herein by reference.

Risk Factors

Under the captions “Effects of Interest Changes,” “Risks Associated with Credit-Sensitive Investments,” “Risks Associated with Owning Real Estate” and “Investment Company Act of 1940” on pages 40 through 46 of the Registrant’s Annual Report to Stockholders for the year ended December 31, 2003 which is incorporated herein by reference, are discussions of risk factors affecting Capstead’s business that are an integral part of this discussion and analysis. Readers are strongly urged to consider these factors while reading this document.

Other Investment Strategies

The Company may enter into other short- or long-term investment strategies as the opportunities arise.

Competition

In purchasing real estate-related assets, the Company competes with others in the real estate and banking industries including REITs, savings banks, commercial banks, mortgage and investment bankers, conduits, insurance companies, other lenders, other real estate investors and mutual funds.

Regulation and Related Matters

Ownership of real estate subjects the Company to various federal, state and local regulatory requirements including those concerned with environmental matters. For further discussion, see the Registrant’s Annual Report to Stockholders for the year ended December 31, 2003 on pages 43 through 45, which is incorporated herein by reference.

Employees

As of December 31, 2003, the Company had eleven full-time employees and three part-time employees.

Tax Status

As used herein, “Capstead REIT” refers to Capstead and the entities that are consolidated with Capstead for federal income tax purposes. Capstead REIT has elected to be taxed as a REIT for federal income tax purposes and intends to continue to do so. As a result of this election, Capstead REIT will not be taxed at the corporate level on taxable income distributed to stockholders, provided that certain requirements concerning the nature and composition of its income and assets are met and that at least 90% of its REIT taxable income is distributed.

If Capstead REIT fails to qualify as a REIT in any taxable year, it would be subject to federal income tax at regular corporate rates and would not receive a deduction for dividends paid to stockholders. If this were the case, the amount of after-tax income available for distribution to stockholders would decrease substantially.

As long as Capstead REIT qualifies as a REIT, it will generally be taxable only on its undistributed taxable income. Distributions out of current or accumulated taxable earnings and profits will be taxed to stockholders as ordinary income or capital gain, as the case may be, and will not qualify for the dividend tax rate reduction to 15% enacted as part of the Jobs and Growth Tax Relief Act of 2002, except as discussed below. Distributions in excess of Capstead REIT’s current or accumulated earnings and profits will constitute a non-taxable return of capital to the stockholders (except insofar as such distributions exceed the cost basis of the shares of stock) resulting in a corresponding reduction in the cost basis of the shares of stock. Distributions by the Company will not be eligible for the dividends received deduction for corporations. Should the Company incur losses, stockholders will not be entitled to include such losses in their individual income tax returns. The Company notifies its stockholders of the proportion of distributions made during the taxable year that constitutes ordinary income, return of capital or capital gains. For the last three years, 100% of the preferred stock distributions were characterized as ordinary income. For information regarding the characterization of common dividend distributions for the last three years, see the Registrants’ Annual Report to Stockholders for the year ended December 31, 2003 on page 35, which is incorporated herein by reference.

Capstead REIT realized substantial capital losses on the sale of mortgage assets in 2000. The remaining unused capital loss carryforwards generated by these transactions of $70.8 million as of December 31, 2003, will likely eliminate the potential for capital gain distributions through the year 2005 when these carryforwards expire.

Capstead may find it advantageous from time-to-time to elect non-REIT subsidiary status for certain of its subsidiaries. All taxable income of Capstead’s non-REIT subsidiaries, if any, is subject to federal and state income taxes, where applicable. Capstead REIT’s taxable income will include the income of its non-REIT subsidiaries only upon distribution of such income to Capstead REIT, and only if these distributions are made out of current or accumulated earnings and profits. Should this occur, a portion of Capstead’s distributions to its stockholders could qualify for the 15% dividend tax rate provided by the Jobs and Growth Tax Relief Act of 2002.

Capstead Inc. (which held Capstead’s mortgage banking operations prior to their sale in December 1998) has elected non-REIT subsidiary status, and as such all of its taxable income is subject to federal and state income taxes, where applicable. However, this non-REIT subsidiary had net operating loss carryforwards for tax purposes of $5.1 million as of December 31, 2003 and sufficient alternative minimum tax credit carryforwards to reduce its effective federal income tax rate from 35% to 20% on up to $12.3 million of its future taxable income, if any.

The foregoing is general in character. Reference should be made to pertinent Internal Revenue Code sections and the Regulations issued thereunder for a comprehensive statement of applicable federal income tax consequences.

Website Access to Company Reports and Other Company Information

Capstead makes available on its website at www.capstead.com, free of charge, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and press releases, including amendments to such documents as soon as reasonably practicable after such materials are electronically filed or furnished to the SEC or otherwise publicly released. The Company also makes available on its website, free of charge, charters for the committees of its board of directors, its Board of Directors Guidelines, its Code of Business Conduct and Ethics, its Financial Officer Code of Conduct and other company information, including amendments to such documents and waivers, if any, to the Codes. Such information will be furnished upon written request to Capstead Mortgage Corporation, Attention: Stockholder Relations, 8401 North Central Expressway, Suite 800, Dallas, Texas 75225-4410.

Forward-looking Statements

For information on forward-looking statements made in this report, see the Registrant’s Annual Report to Stockholders for the year ended December 31, 2003 on page 47, which is incorporated herein by reference.

ITEM 2. PROPERTIES.

The Company’s headquarters are located in Dallas, Texas in office space leased by the Company. As of December 31, 2003 the Company owned six independent senior living facilities located in five states. For further information, see the Registrant’s Annual Report to Stockholders for the year ended December 31, 2003 on pages 15, 16 and 33, which is incorporated herein by reference.

ITEM 3. LEGAL PROCEEDINGS.

During 1998, twenty-four purported class action lawsuits were filed against Capstead and certain of its officers alleging, among other things, that the defendants violated federal securities laws by publicly issuing false and misleading statements and omitting disclosure of material adverse information regarding the Company’s business. In March 2003 the court granted the Company and named officers’ motions to dismiss and entered an order dismissing the amended complaint and denying the plaintiffs’ request to further amend their complaint. In November 2003, the plaintiff’s opportunity to appeal this dismissal to the Fifth Circuit Court of Appeals passed. With the dismissal of this case without appeal, the Company recovered from its insurance carrier a $500,000 deductible originally expensed in 1998 and 1999. This recovery was recorded in Other Revenue when received during the fourth quarter of 2003.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

The information required by this item regarding the market price of, dividends on, and number of holders of the Registrant’s common shares is included in the Registrant’s Annual Report to Stockholders for the year ended December 31, 2003 on page 27 under the caption “Note 18 — Market and Dividend Information,” and is incorporated herein by reference. See ITEM 12 for information regarding equity compensation plans. Capstead did not sell any unregistered securities during the past three fiscal years.

ITEM 6. SELECTED FINANCIAL DATA.

The information required by this item is included in the Registrant’s Annual Report to Stockholders for the five years ended December 31, 2003 on page 28 under the caption “Selected Financial Data,” and is incorporated herein by reference.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The information required by this item is included in the Registrant’s Annual Report to Stockholders for the year ended December 31, 2003 on pages 29 through 48 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and is incorporated herein by reference.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The information required by this item is included in the Registrant’s Annual Report to Stockholders for the year ended December 31, 2003 on pages 3 through 27, and is incorporated herein by reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

ITEM 9A. CONTROLS AND PROCEDURES

The information required by this item is included in the Registrant’s Annual Report to Stockholders for the year ended December 31, 2003 on page 48, and is incorporated herein by reference.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

The information required by this item is included in the Registrant’s 2004 definitive Proxy Statement on pages 4 and 5 under the caption “Proposal Number One — Election of Directors,” on page 7 under the caption “Board Committees and Meetings,” on pages 9 and 10 under the caption “Stockholder Procedures for Recommending a Candidate for Director,” on page 11 under the caption “Executive Officers,” on page 19 under the captions “Audit Committee” and “Audit Committee Report” and on page 21 under the caption “Compliance with Section 16(a) of the Securities Exchange Act of 1934,” all of which are incorporated herein by reference.

Capstead has adopted its Code of Business Conduct and Ethics that applies to all directors, officers and employees, and its Financial Officer Code of Conduct that applies to its chief executive officer, chief financial officer and other officers with a role in the Company’s financial accounting and reporting process. These codes and waivers thereto, if any, are available on the Company’s website at www.capstead.com.

ITEM 11. EXECUTIVE COMPENSATION.

The information required by this item is included in the Registrant’s 2004 definitive Proxy Statement on pages 12 through 14 under the caption “Executive Compensation,” which is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item is included in the Registrant’s 2004 definitive Proxy Statement on page 14 under the caption “Equity Compensation Plans” and pages 20 and 21 under the caption “Security Ownership of Management and Certain Beneficial Owners,” which is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information required by this item is included in the Registrant’s 2004 definitive Proxy Statement on page 21 under the caption “Certain Relationships and Related Transactions,” which is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

The information required by this item is included in the Registrant’s 2004 definitive Proxy Statement on page 22 under the caption “Proposal Number Two - Ratification of the Appointment of Ernst & Young LLP as Our Auditors,” which is incorporated here in by reference.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(a) Documents filed as part of this report:

1. The following consolidated financial statements of the Company, included in the 2003 Annual Report to Stockholders, are incorporated herein by reference:


	Page
Consolidated Statements of Operations — Three Years Ended December 31, 2003		*
Consolidated Balance Sheets — December 31, 2003 and 2002		*
Consolidated Statements of Stockholders’ Equity and Preferred Stock Subject to Repurchase — Three Years Ended December 31, 2003		*
Consolidated Statements of Cash Flows — Three Years Ended December 31, 2003		*
Notes to Consolidated Financial Statements — December 31, 2003		*

2. Financial Statement Schedules — All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.

* Incorporated herein by reference from the Company’s Annual Report to Stockholders for the year ended December 31, 2003, filed herewith as Exhibit 13.

3. Exhibits:


Exhibit
Number
1.1		Form of First Amendment to Sales Agreement dated December 16, 2003 by and between Capstead and Brinson Patrick Securities Corporation, for the issuance of up to 875,000 common shares and 1,000,000 Series B preferred shares(6)
1.2		Form of Sales Agreement dated February 13, 2004 by and between Capstead and Brinson Patrick Securities Corporation to sell 1,000,000 common shares, and 100,000 Series B preferred shares(7)
3.1		Charter, including Articles of Incorporation, Articles Supplementary for each series of preferred shares and all other amendments to such Articles of Incorporation(4)
3.2		Amended and Restated Bylaws(4)
10.01		1990 Directors’ Stock Option Plan(1)
10.02		1994 Flexible Long-Term Incentive Plan, as amended (2)
10.03		1994 Capstead Inc. Restricted Stock Plan(2)
10.04		Deferred Compensation Plan(2)
10.05		1997 Flexible Long Term Incentive Plan(3)
12		Computation of ratio of earnings to combined fixed charges and preferred stock dividends*
13		Portions of the Company’s Annual Report to Stockholders for the year ended December 31, 2003*
21		List of subsidiaries of the Company*


Exhibit
Number
23		Consent of Ernst & Young LLP, Independent Auditors*
31.1		Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002*
31.2		Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002*
32		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

(1) Incorporated by reference to the Company’s Registration Statement on Form S-8 (No. 33-40017) dated April 29, 1991

(2) Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1994

(3) Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 1997

(4) Incorporated by reference to the Company’s Registration Statement on Form S-3 (No. 333-63358) dated June 19, 2001

(5) Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001

(6) Incorporated by reference to the Company’s Post-Effective Amendment No. 1 to the Registration Statement on Form S-3 (No. 333-68424) dated December 17, 2003

(7) Incorporated by reference to the Company’s Registration Statement on Form S-3 dated February 17, 2004

* Filed herewith

(b) Reports on Form 8-K:

Current Report on Form 8-K dated October 22, 2003 to furnish the Company’s press release announcing third quarter results.

Current Report on Form 8-K dated January 28, 2004 to furnish the Company’s press release announcing fourth quarter results, record date for annual meeting and common dividend schedule for 2004.

(c) Exhibits — The response to this section of ITEM 15 is submitted as a separate section of this report.

(d) Financial Statement Schedules — The response to this section of ITEM 15 is submitted as a separate section of this report.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

CAPSTEAD MORTGAGE CORPORATION
Registrant

Date: March 3, 2004 By: /s/ ANDREW F. JACOBS
Andrew F. Jacobs
President and Chief Executive Officer

Date: March 3, 2004 By: /s/ PHILLIP A. REINSCH
Phillip A. Reinsch
Senior Vice President and Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated below and on the dates indicated.


/s/ PAUL M. LOW (Paul M. Low)	Chairman and Director	March 3, 2004
/s/ ANDREW F. JACOBS (Andrew F. Jacobs)	President, Chief Executive Officer and Director	March 3, 2004
/s/ GARY KEISER (Gary Keiser)	Director	March 5, 2004
/s/ MICHAEL G. O’NEIL (Michael G. O’Neil)	Director	March 3, 2004
/s/ HOWARD RUBIN (Howard Rubin)	Director	March 4, 2004
/s/ MARK S. WHITING (Mark S. Whiting)	Director	March 6, 2004

INDEX TO EXHIBITS


EXHIBIT
NUMBER		DESCRIPTION
1.1		Form of First Amendment to Sales Agreement dated December 16, 2003 by and between Capstead and Brinson Patrick Securities Corporation, for the issuance of up to 875,000 common shares and 1,000,000 Series B preferred shares(6)
1.2		Form of Sales Agreement dated February 13, 2004 by and between Capstead and Brinson Patrick Securities Corporation to sell 1,000,000 common shares, and 100,000 Series B preferred shares(7)
3.1		Charter, including Articles of Incorporation, Articles Supplementary for each series of preferred shares and all other amendments to such Articles of Incorporation(4)
3.2		Amended and Restated Bylaws(4)
10.01		1990 Directors’ Stock Option Plan(1)
10.02		1994 Flexible Long-Term Incentive Plan, as amended (2)
10.03		1994 Capstead Inc. Restricted Stock Plan(2)
10.04		Deferred Compensation Plan(2)
10.05		1997 Flexible Long Term Incentive Plan(3)
12		Computation of ratio of earnings to combined fixed charges and preferred stock dividends*
13		Portions of the Company’s Annual Report to Stockholders for the year ended December 31, 2003*
21		List of subsidiaries of the Company*
23		Consent of Ernst & Young LLP, Independent Auditors*
31.1		Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002*
31.2		Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002*
32		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

EX-12 3 d13093exv12.htm COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES exv12

EXHIBIT 12

CAPSTEAD MORTGAGE CORPORATION
COMPUTATION OF RATIO OF EARNINGS TO COMBINED
FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
(In thousands, except ratios)
(Unaudited)

(a) Computation of ratio of earnings to combined fixed charges and preferred stock dividends (including CMO debt):


	Year Ended December 31
	2003		2002		2001		2000			1999
Fixed charges	$	62,859	$	169,148	$	362,327	$	540,605		$	502,933
Preferred stock dividends		20,273		20,362		20,446		24,260			22,556

Combined fixed charges and preferred stock dividends	$	83,132	$	189,510	$	382,773	$	564,865		$	525,489

Fixed charges	$	62,859	$	169,148	$	362,327	$	540,605		$	502,933
Net income (loss)		60,659		96,123		106,276		(51,486	)		57,909

	$	123,518	$	265,271	$	468,603	$	489,119		$	560,842

Ratio of earnings to combined fixed charges and preferred stock dividends		1.49:1		1.40:1		1.22:1		0.87:1			1.07:1

(b) Computation of ratio of earnings to combined fixed charges and preferred stock dividends (excluding CMO debt):


	Year Ended December 31
	2003		2002		2001		2000			1999
Fixed charges	$	28,933	$	53,079	$	164,422	$	303,126		$	232,852
Preferred stock dividends		20,273		20,362		20,446		24,260			22,556

Combined fixed charges and preferred stock dividends	$	49,206	$	73,441	$	184,868	$	327,386		$	255,408

Fixed charges	$	28,933	$	53,079	$	164,422	$	303,126		$	232,852
Net income (loss)		60,659		96,123		106,276		(51,486	)		57,909

	$	89,592	$	149,202	$	270,698	$	251,640		$	290,761

Ratio of earnings to combined fixed charges and preferred stock dividends		1.82:1		2.03:1		1.46:1		0.77:1			1.14:1

EX-13 4 d13093exv13.txt 2003 ANNUAL REPORT TO STOCKHOLDERS EXHIBIT 13 CAPSTEAD MORTGAGE CORPORATION PORTIONS OF THE ANNUAL REPORT TO STOCKHOLDERS FOR THE YEAR ENDED DECEMBER 31, 2003 Report of Independent Auditors 3 Consolidated Statements of Operations 4 Consolidated Balance Sheets 5 Consolidated Statements of Stockholders' Equity and Preferred Stock Subject to Repurchase 6 Consolidated Statements of Cash Flows 7 Notes to Consolidated Financial Statements 8 Selected Financial Data 28 Management's Discussion and Analysis of Financial Condition and Results of Operations 29 Directors 49 Officers 50 CAPSTEAD MORTGAGE CORPORATION REPORT OF INDEPENDENT AUDITORS Stockholders and Board of Directors Capstead Mortgage Corporation We have audited the accompanying consolidated balance sheets of Capstead Mortgage Corporation as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders' equity and preferred stock subject to repurchase, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Capstead Mortgage Corporation at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Dallas, Texas January 28, 2004 3 CAPSTEAD MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)

See accompanying notes to consolidated financial statements. 4 CAPSTEAD MORTGAGE CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts)

See accompanying notes to consolidated financial statements. 5 CAPSTEAD MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND PREFERRED STOCK SUBJECT TO REPURCHASE (In thousands, except per share amounts)

See accompanying notes to consolidated financial statements. 6 CAPSTEAD MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)

See accompanying notes to consolidated financial statements. 7 CAPSTEAD MORTGAGE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003 NOTE 1 -- BUSINESS Capstead Mortgage Corporation (together with its subsidiaries, "Capstead" or the "Company") operates as a real estate investment trust ("REIT") earning income from investing in real estate-related assets on a leveraged basis and from other investment strategies. These investments primarily consist of, but are not limited to, financial assets, specifically residential adjustable-rate mortgage ("ARM") securities issued by government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities"). Capstead has also made limited investments in credit-sensitive commercial real estate-related assets, including the direct ownership of real estate. Management believes that such investments, when available at favorable prices and combined with the prudent use of leverage, can produce attractive risk-adjusted returns over the long term with relatively low sensitivity to changes in interest rates. The earning capacity of Capstead's financial asset portfolios is influenced by the overall size and composition of the portfolios, the relationship between short- and long-term interest rates (the "yield curve") and the extent the Company continues to invest its liquidity in these portfolios. Although having moderated considerably during the fourth quarter of 2003 and into early 2004, runoff caused by mortgage prepayments remains a significant challenge to earnings generated by these portfolios. To the extent the proceeds of mortgage prepayments and other maturities are not reinvested or cannot be reinvested at a rate of return on invested capital at least equal to the return earned on previous investments, earnings and common dividends may decline. NOTE 2 -- ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Capstead Mortgage Corporation and its subsidiaries, including certain finance and real estate subsidiaries. Intercompany balances and transactions have been eliminated. Substantially all of the assets of the finance subsidiaries are pledged to secure collateralized mortgage obligations ("CMOs") and are not available for the satisfaction of general claims of Capstead. Similarly, real estate held for lease and related assets are owned by real estate subsidiaries and pledged to secure related borrowings. Capstead has no responsibility for CMOs or borrowings secured by real estate beyond the assets pledged as collateral. USE OF ESTIMATES The use of estimates is inherent in the preparation of financial statements in conformity with accounting principles generally accepted in the United States. The amortization of premiums and discounts on mortgage assets and CMOs is based on estimates of future prepayments on underlying mortgage loans, which are impacted by future changes in interest 8 CAPSTEAD MORTGAGE CORPORATION rates and other factors beyond the control of management. Actual results could differ from those estimates, which could adversely affect earnings. Similarly, depreciation on real estate is based on estimates of the useful lives of buildings, equipment and fixtures, which could be affected by significant adverse events or changes in circumstances and potentially lead to impairment charges. Estimated fair values of debt securities have been determined using available market information and appropriate valuation methodologies; however, considerable judgment is required in interpreting market data to develop these estimates. In addition, fair values fluctuate on a daily basis. Accordingly, estimates of fair value as of the balance sheet dates are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on estimated fair values, which would affect Accumulated other comprehensive income in stockholders' equity and the calculation of incentive fees. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current year presentation. FINANCIAL ASSETS Financial assets held in the form of asset-backed securities are debt securities. Management determines the appropriate classification of debt securities at the time of purchase and periodically reevaluates such designation. Debt securities may be classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are stated at fair value with unrealized gains and losses reported as a separate component of Accumulated other comprehensive income in stockholders' equity. Financial assets held in the form of whole loans are carried at their unpaid principal balances, net of unamortized discount or premium. The Company may from time to time hold loans for sale. Such loans are carried at the lower of cost or market on an aggregate basis. Transfers from loans for sale to loans for investment are recorded at the lower of cost or market. Interest is recorded as income when earned. Premiums and discounts are recognized as adjustments to Interest income by the interest method over the life of the related financial asset. Realized gains and losses are included in Other revenue (expense). The cost of financial assets sold is based on the specific identification method. Unrealized gains and losses are not amortized to income; however, if a decline in fair value of an individual financial asset below amortized cost basis occurs that is determined to be other than temporary, the difference between amortized cost and fair value is included in Other revenue (expense) as an impairment charge. No impairment charges on financial assets have been recorded during the three years ended December 31, 2003. REAL ESTATE HELD FOR LEASE Land, buildings, equipment and fixtures are carried at cost less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the depreciable assets (40 years for buildings and five years for equipment and fixtures). Should a significant adverse event or change in circumstances occur, the values of real estate 9 CAPSTEAD MORTGAGE CORPORATION properties will be assessed for impairment. A property is considered impaired only if estimated operating cash flows (undiscounted and without interest charges) over its remaining useful life are less than net carrying value. If impaired, the difference between net carrying value and fair value would be included in Other revenue (expense) as an impairment charge. No impairment charges have been recorded during the period from May 2002 (acquisition date of the Company's first direct investment in real estate - see NOTE 6) through December 31, 2003. REAL ESTATE LEASE INCOME RECOGNITION Base rents are recognized on a straight-line basis over the term of the related leases. Base rent escalations, when present, are recognized when earned if dependent upon unknown factors such as future increases in the Consumer Price Index. CASH AND CASH EQUIVALENTS Cash and cash equivalents include unrestricted cash on hand and highly liquid investments with original maturities of three months or less when purchased. DERIVATIVE FINANCIAL INSTRUMENTS The Company may from time to time acquire derivative financial instruments ("Derivatives") for risk management purposes. These may include interest rate floors, swaps and caps, U.S. Treasury futures contracts and options, written options on financial assets or various other Derivatives available in the marketplace that are compatible with the Company's risk management objectives. The Company has made limited use of Derivatives during the three years ended December 31, 2003. Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") requires the recognition of Derivatives as assets or liabilities on the balance sheets and measurement of those instruments at fair value. The Company adopted SFAS 133 on January 1, 2001 and recognized in Other comprehensive income (loss) as cash flow hedge instruments certain call rights on securitizations previously issued by the Company that were originally accounted for as sales. These call rights, which were subsequently all exercised, allowed Capstead to acquire a modest amount of ARM securities at par value. The fair value of these call rights was based on the discounted fair value of the related ARM securities in excess of par, less transaction costs. As such, changes in the value of the call rights were 100% correlated to changes in value of the ARM securities, excluding the effects of time value, which were recorded in Other revenue (expense). Upon exercise, the ARM securities were recorded at par and the value of the related call right was reclassified as an investment premium and amortized to Interest income as a yield adjustment. The related amount recorded in Accumulated other comprehensive income is also amortized to Interest income concurrently with the loan premium. Included in Receivables and other assets are interest rate caps acquired in connection with the 2002 assumption and subsequent refinancing of tax-exempt bonds secured by real estate held for lease (see NOTE 9). Changes in value of the caps are considered 100% correlated to changes in expected future cash flows of the variable-rate bonds, excluding the effects of time value. Accordingly, changes in time value are amortized to Interest expense as a yield adjustment and other changes in value are recorded in Accumulated other comprehensive income. 10 CAPSTEAD MORTGAGE CORPORATION BORROWINGS Repurchase arrangements and other borrowings, including CMOs and borrowings secured by real estate, are carried at their unpaid principal balances, net of unamortized discounts and premiums. Discounts and premiums, as well as debt issue costs, which are recorded in Receivables and other assets, are recognized as adjustments to Interest and related expense by the interest method over the expected term of the related borrowings. INCOME TAXES Capstead and its qualified REIT subsidiaries ("Capstead REIT") have elected to be taxed as a REIT. As a result of this election, Capstead REIT is not taxed on taxable income distributed to stockholders if certain REIT qualification tests are met. It is Capstead's policy to distribute 100% of taxable income of the REIT within the time limits prescribed by the Internal Revenue Code of 1986 (the "Code"), which may extend into the subsequent taxable year. Accordingly, no provision has been made for income taxes for Capstead REIT. Capstead may find it advantageous from time to time to elect non-REIT subsidiary status for certain of its qualified REIT subsidiaries. All taxable income of Capstead's non-REIT subsidiaries is subject to federal and state income taxes, where applicable. Income taxes are accounted for using the liability method, and deferred income tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. INCENTIVE FEES Management and employees participate in an incentive compensation program established by the Board of Directors. Until July 22, 2003, management included an affiliate of Fortress Investment Group LLC. Fortress Investment Group LLC, together with its affiliates, is referred to as "Fortress." Fortress was the Company's controlling stockholder, and its chairman of the board was also Capstead's Chairman of the Board and Chief Executive Officer (see NOTE 15). Under the terms of the program, incentive fee amounts are determined based on a 10% participation in the "modified total return" of Capstead in excess of a 10% benchmark return, multiplied by the Company's beginning "modified common book value." Modified total return under the program is measured as the change in modified common book value per share during the year, together with common dividends per share. For the two years in the period ended December 31, 2002, modified common book value was determined by deducting from total equity the recorded value of preferred equity and unrealized gains and losses on assets classified as held-to-maturity, and adding back incentive fee accruals. For the year ended December 31, 2003, the modified book value calculation was adjusted further to include all unrealized gains and losses on investments not included in Accumulated other comprehensive income, such as real estate held for lease. STOCK-BASED COMPENSATION As more fully described in NOTE 13, the Company accounts for stock-based awards for employees and directors under the recognition and measurement principles of the Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations ("APB25"). Under APB25 compensation cost for stock-based awards for 11 CAPSTEAD MORTGAGE CORPORATION employees and directors is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount to be paid to acquire the stock and is recognized in Other operating expense as the awards vest and restrictions lapse on a straight-line basis. The increase in total stock-based compensation expense if determined under the fair value-based methodology prescribed under Statement of Financial Accounting Standards No. 123 "Accounting for Stock-based Compensation" ("SFAS 123") would have been $35,000, $84,000, and $88,000 in 2003, 2002 and 2001, respectively, which would have had no effect on reported diluted net income per common share in 2003 and 2002 and a one cent per common share effect in 2001. NET INCOME PER COMMON SHARE Basic net income per common share is computed by dividing net income, after deducting preferred share dividends, by the weighted average number of common shares outstanding. Diluted net income per common share is computed by dividing net income, after deducting preferred share dividends for antidilutive convertible preferred shares, by the weighted average number of common shares and common share equivalents outstanding, giving effect to dilutive stock options and dilutive convertible preferred shares. NOTE 3 -- CALCULATION OF NET INCOME PER COMMON SHARE The components of the computation of basic and diluted net income per share were as follows (in thousands, except per share data):

12 CAPSTEAD MORTGAGE CORPORATION

For dilutive net income per share purposes, the Series A and B preferred shares are considered dilutive whenever annualized basic net income per share exceeds each Series' annualized dividend divided by the conversion rate applicable for that period. The Series A preferred shares were dilutive throughout the last three years. The Series B preferred shares became dilutive July 2, 2001 after a new conversion rate went into effect, even though few Series B conversions occurred because it was uneconomical to convert at the market prices of the common shares and Series B preferred shares in effect during these periods. NOTE 4 -- MORTGAGE SECURITIES AND SIMILAR INVESTMENTS The Company classifies its mortgage securities and similar investments by collateral type and interest rate characteristics. Agency Securities are AAA-rated and are considered to have limited credit risk. Non-agency securities consist of private mortgage pass-through securities originally formed prior to 1995 when the Company operated a mortgage conduit. These securities are backed by residential mortgage loans whereby the related credit risk of the underlying loans is either borne by AAA-rated private mortgage insurers or by the Company ("Non-agency Securities"). Included in Receivables and other assets as restricted cash at December 31, 2003 are $6.1 million in related special hazard (e.g. earthquake or mudslide-related losses) and bankruptcy reserve funds. Commercial mortgage securitizations generally have senior, mezzanine and subordinate classes of bonds with the lower bond classes providing credit enhancement to the more senior classes. Commercial mortgage-backed securities ("CMBS") held by the Company as of December 31, 2003 are mezzanine classes and therefore carry credit risk associated with the underlying pools of commercial mortgage loans that is mitigated by subordinate bonds held by other investors. The maturity of mortgage securities is directly affected by the rate of principal prepayments on the underlying loans. Fixed-rate investments have fixed rates of interest and initial expected weighted average lives of greater than five years. Adjustable-rate investments have interest rates that adjust at least annually to more current interest rates. For instance, mortgage loans underlying ARM securities either (i) adjust annually based on a specified margin over the one-year Constant Maturity U.S. Treasury Note Rate ("One-year CMT"), (ii) adjust semiannually based on a specified margin over the six-month London Interbank Offered Rate ("LIBOR"), or (iii) adjust monthly based on a specific margin over an index such as LIBOR or the Cost of Funds Index as published by the Eleventh District Federal Reserve Bank ("COFI") subject to periodic and lifetime limits on the amount of such adjustments during any single interest rate 13 CAPSTEAD MORTGAGE CORPORATION adjustment period and over the life of the loan. CMBS held as of December 31, 2003 adjust monthly based on a specified margin over 30-day LIBOR. Mortgage securities and similar investments and the related average effective interest rates were as follows (dollars in thousands):

(a) Includes mark-to-market for securities classified as available-for-sale, if applicable (see NOTE 10). (b) Average Coupon Rate is presented net of servicing and other fees as of the indicated balance sheet date. Average Effective Rate is presented for the year then ended, calculated including the amortization of premiums and discounts, mortgage insurance costs on Non-agency Securities and excluding unrealized gains and losses. (c) As of the indicated dates, these portfolios consisted of adjustable-rate investments. NOTE 5 -- CMO COLLATERAL AND INVESTMENTS CMO collateral consists of Non-Agency Securities and related accrual interest and short-term investments, all pledged to secure CMO borrowings ("Pledged CMO Collateral"). All principal and interest on pledged mortgage securities is remitted directly to collection accounts maintained by a trustee. The trustee is responsible for reinvesting those funds in 14 CAPSTEAD MORTGAGE CORPORATION short-term investments. Related collections and the reinvestment income earned thereon are available for the payment of principal and interest on CMO borrowings. The components of CMO collateral and investments were as follows (in thousands):

Credit risk associated with Pledged CMO Collateral is borne by AAA-rated private mortgage insurers or subordinated bonds within the related CMO series to which the collateral is pledged. With recent redemptions of previously issued CMOs, the Company no longer has credit risk retained in the form of subordinate bonds associated with Pledged CMO Collateral. The weighted average effective interest rate for CMO collateral and investments was 6.20% and 6.88% during 2003 and 2002, respectively. NOTE 6 -- REAL ESTATE HELD FOR LEASE In May 2002 Capstead acquired six "independent" senior living facilities (wherein the operator of the facility provides most of the tenants little, if any, medical care) and one skilled nursing facility (collectively, the "Properties"). In October 2002, the skilled nursing facility was sold for cash proceeds of approximately $4.1 million, net of selling costs. No gain or loss was recognized on this transaction. After adjustment for the sale of the skilled nursing facility, the aggregate purchase price of the Properties was $139.7 million including approximately $3.1 million in closing costs and the assumption by Capstead of $19.7 million of related mortgage debt and $101.1 million of tax-exempt bond debt. The Properties were acquired pursuant to purchase agreements initially negotiated and executed by an affiliate of Brookdale Living Communities, Inc. (collectively with its subsidiaries, "Brookdale") with an affiliate of Apartment Investment Management Company ("AIMCO") and subsequently assigned to Capstead. Concurrent with the acquisition, the Company entered into a long-term "net-lease" arrangement with Brookdale, under which Brookdale is responsible for the ongoing operation and management of the Properties. Brookdale, an owner, operator, developer and manager of senior living facilities, is a majority-owned affiliate of Fortress. The lease arrangement consists of a master lease covering all of the Properties and individual property-level leases (referred to collectively as the "Lease"). The Lease has an initial term of 20 years and provides for two 10-year renewal periods. Beginning May 1, 2007, Brookdale will have the option of purchasing all of the Properties from Capstead at the greater of fair value or Capstead's original cost, after certain adjustments. After an initial three-month rent concession period, Brookdale is responsible for paying all expenses associated with the operation of the Properties, including real estate taxes, other governmental charges, insurance, utilities and maintenance, and an amount representing an 15 CAPSTEAD MORTGAGE CORPORATION attractive cash return on Capstead's equity in the Properties after payment of monthly debt service subject to annual increases based upon increases (capped at 3%) in the Consumer Price Index. Because under the terms of the Lease, Brookdale is responsible for changes in related debt service requirements, earnings from this investment are generally not affected by changes in interest rates. The Lease qualifies as an operating lease for financial reporting purposes with future minimum rentals expected to approximate $10 million per year for each of the next five years, provided Brookdale does not exercise its option to purchase all of the Properties. Included in Receivables and other assets at December 31, 2003 are $3.1 million in unamortized rent abatements and $1.5 million of other rent receivables from Brookdale. The following table summarizes carrying amounts of the Properties (in thousands):

Concurrent with executing the purchase agreements for the Properties, Brookdale also entered into an agreement with AIMCO to acquire from AIMCO $71.4 million of the tax-exempt bonds secured by the Properties held by a tax-exempt bond fund (the "TEB Fund Bonds") for a purchase price of $60.7 million. With Capstead's acquisition of the Properties and assumption of the bonds, Brookdale agreed to release AIMCO from its obligation to deliver the TEB Fund Bonds pursuant to the bond purchase agreement in exchange for which AIMCO paid Brookdale $4.6 million and Brookdale simultaneously entered into a two-year total return swap agreement with respect to the TEB Fund Bonds with a notional swap strike price of $65.4 million. The swap was terminated in November 2002 when the bonds were refinanced (see NOTE 9) resulting in a net payment to Brookdale of $6.0 million. The swap counterparty was a financial institution affiliated with the tax-exempt bond fund. Capstead did not directly benefit from these agreements. NOTE 7 -- REPURCHASE ARRANGEMENTS AND SIMILAR BORROWINGS Capstead borrows under uncommitted repurchase arrangements with only well-established investment banking firms. Repurchase arrangements pursuant to which the Company pledges Agency and Non-agency Securities as collateral generally have maturities of less than 31 days. Repurchase arrangements with CMBS pledged as collateral generally have longer initial maturities and may feature renewal options. The terms and conditions of repurchase arrangements and similar borrowings are negotiated on a transaction-by-transaction basis. 16 CAPSTEAD MORTGAGE CORPORATION Repurchase arrangements and similar borrowings, classified by type of collateral, maturities and related weighted average interest rates for the dates indicated, were as follows (dollars in thousands):

The weighted average effective interest rate on repurchase arrangements and similar borrowings was 1.23% and 1.79% during 2003 and 2002, respectively. Interest paid on these borrowings totaled $24.7 million, $50.0 million, and $180.7 million during 2003, 2002 and 2001, respectively. NOTE 8 -- CMO BORROWINGS Each series of CMOs issued consists of various classes of bonds, most of which have fixed rates of interest. Interest is payable monthly at specified rates for all classes. Typically, principal payments on each series are made to each class in the order of their stated maturities so that no payment of principal is made on any class of bonds until all classes having an earlier stated maturity have been paid in full. The components of CMOs, along with selected other information, were as follows (dollars in thousands):

The maturity of each CMO series is directly affected by the rate of principal prepayments on the related Pledged CMO Collateral. Each series is also subject to redemption provided that certain requirements specified in the related indenture have been met (referred to as "Clean-up Calls"); therefore, the actual maturity of any series is likely to occur earlier than its stated maturity. The weighted average effective interest rate for all CMOs was 6.12% and 7.02% during 2003 and 2002, respectively. Interest paid on CMOs totaled $40.3 million, $117.6 million and $194.5 million during 2003, 2002 and 2001, respectively. 17 CAPSTEAD MORTGAGE CORPORATION NOTE 9 -- BORROWINGS SECURED BY REAL ESTATE The components of borrowings secured by real estate and related weighted average interest rates (calculated including bond issue cost amortization) were as follows (dollars in thousands):

Mortgage borrowings consist of a fixed-rate mortgage secured by one senior living facility that matures in 2009. The tax-exempt bonds are credit-enhanced by Fannie Mae and secured by mortgages on the remaining five senior living facilities. Interest rates on the bonds adjust weekly based on the Bond Market Association Municipal Swap Index ("BMA Index"). Interest rate cap agreements with notional amounts aggregating $100.8 million, five-year terms and cap rates equal to a 6% BMA Index are held to provide funds to pay interest on the bonds in excess of a 6% BMA Index, should that occur. The interest rate cap agreements were valued at $317,000 and $587,000 at December 31, 2003 and 2002, respectively, and are included in Receivables and other assets. Monthly principal and interest rate cap reserve fund payments are made to the trustee for the eventual retirement of the bonds by 2032 and the purchase of new cap agreements in 2007. In connection with the issuance of new tax-exempt bonds in November 2002, Capstead placed into escrow with the trustee reserves for repairs and replacements totaling $2.7 million. During 2003, the trustee released $1.5 million of these funds. Another $6.1 million is held by the trustee in connection with Capstead posting a $6.0 million letter of credit from a rated financial institution to collateralize certain of the bonds. These funds, along with $1.4 million of principal and interest rate cap reserve funds, are included in Receivables and other assets as restricted cash. Also included in Receivables and other assets are $3.2 million in bond issue costs. The weighted average effective interest rate for all borrowings secured by real estate (calculated including bond issue cost amortization) was 3.59% and 5.87% during 2003 and 2002, respectively. Interest paid on borrowings secured by real estate totaled $4.3 million and $4.8 million during 2003 and 2002, respectively. As of December 31, 2003 future maturities and principal reserve fund requirements for these borrowings were as follows (in thousands):

18 CAPSTEAD MORTGAGE CORPORATION NOTE 10 -- DISCLOSURES REGARDING FAIR VALUES OF FINANCIAL INSTRUMENTS The carrying amounts of cash and cash equivalents, restricted cash, receivables, payables and repurchase arrangements and similar borrowings approximate fair value. The fair value of Derivatives, Agency Securities, Non-agency Securities, CMBS, CMO investments and borrowings secured by real estate were estimated using either (i) quoted market prices when available, including quotes made by lenders in connection with designating collateral for repurchase arrangements, or (ii) offer prices for similar assets or market positions. The fair value of Pledged CMO Collateral was based on projected cash flows, after payment on the related CMOs, determined using market discount rates and prepayment assumptions. The fair value of CMOs was based on the same method for determining fair value of Pledged CMO Collateral adjusted for credit enhancements. The maturity of mortgage assets is directly affected by the rate of principal payments on the underlying mortgage loans and, for Pledged CMO Collateral, Clean-up Calls of the remaining CMOs outstanding. Fair value disclosures for financial instruments were as follows (in thousands):

Fair value disclosures for available-for-sale debt securities were as follows (in thousands):

19 CAPSTEAD MORTGAGE CORPORATION

Held-to-maturity debt securities consist of Pledged CMO Collateral and collateral released from the related CMO indentures pursuant to Clean-up Calls and held as Agency or Non-agency Securities. Fair value disclosures for debt securities held-to-maturity were as follows (in thousands):

Sales of released CMO collateral occasionally occur provided the collateral has paid down to within 10% of its original issuance amounts. Sales of debt securities were as follows (in thousands):

20 CAPSTEAD MORTGAGE CORPORATION NOTE 11 -- INCOME TAXES Capstead REIT files a separate federal income tax return that does not include the operations of the Company's non-REIT subsidiaries. Provided all taxable income of Capstead REIT is distributed to stockholders within time limits prescribed by the Code, no income taxes are due on this income. Taxable income, if any, of the non-REIT subsidiaries is fully taxable. The non-REIT subsidiaries paid alternative minimum taxes of $81,000 during 2002. No income taxes were paid during 2003 and 2001. Effective tax rates differed substantially from statutory federal income tax rates because of the effect of the following items (in thousands):

At December 31, 2003, Capstead REIT had capital loss carryforwards for tax purposes of $70.8 million, that expire after 2005. At December 31, 2003, the non-REIT subsidiaries had net operating loss carryforwards for tax purposes of $5.1 million, which expire after 2019, and capital loss carryforwards of $159,000, which expire after 2006. In addition, the non-REIT subsidiaries have sufficient alternative minimum tax credit carryforwards to reduce the effective federal tax rate from 35% to 20% on up to $12.3 million of taxable income, if any, earned by these non-REIT subsidiaries. Significant components of the non-REIT subsidiaries deferred income tax assets and liabilities were as follows (in thousands):

21 CAPSTEAD MORTGAGE CORPORATION NOTE 12 -- STOCKHOLDERS' EQUITY As of December 31, 2003, the Company had two series of convertible preferred stock outstanding ranking on parity with each other and ahead of the common shares in the event of liquidation. These shares are currently redeemable at the Company's option. Dividends are payable quarterly for the Series A shares and monthly for the Series B shares. Under the terms of the governing Articles Supplementary, common dividend distributions in excess of available quarterly net income results in adjustments to the conversion ratios of the preferred shares. Capstead's preferred shares are each entitled to cumulative fixed dividends with conversion rates and redemption and liquidation preferences as indicated below:

* Reflects number of common shares to be received for each preferred share converted effective January 1, 2004 for the Series A shares and December 31, 2003 for the Series B shares. During 2003, 7,300 Series A shares and 100 Series B shares were converted into 10,651 and 56 common shares, respectively. In December 1999 Capstead issued 5,378,000 of Series C preferred shares and 5,378,000 of Series D preferred shares to Fortress that were converted in May 2001 and December 2000, respectively, into an aggregate of 2,689,000 common shares. In addition, during 2000 Fortress acquired an aggregate of 1,960,359 Capstead common shares through open market purchases and a May 2000 tender offer, bringing its holdings to 4,649,359 common shares. In November 2001, Fortress sold one million of these shares in an underwritten offering and by July 2003 had sold its remaining Capstead shares in open market sales (see NOTE 15). In March 2001 the Company repurchased 275,845 common shares at a price of $26.50 per share (including transaction costs) pursuant to a tender offer. These shares were cancelled. Option exercises by officers resulted in net additions to capital of $117,000, $209,000 and $747,000 during 2003, 2002 and 2001, respectively. Option exercises by directors resulted in net additions to capital of $419,000 during 2001. No options were exercised by directors in 2003 or 2002. Beginning the second quarter of 2002, common dividend distributions have exceeded available net income reflecting the decision to distribute amounts representing depreciation on Real estate held for lease, a noncash item. In addition, similar to a $14.60 per common share special dividend paid in June 2001, the fourth quarter 2002 common dividend included a special dividend of $7.19 per common share representing a significant portion of the Company's common stockholders' equity. Amounts paid as regular quarterly common dividends in excess of quarterly net income, as well as the special dividends, were recorded as reductions to Paid-in capital. Capstead's Charter provides that if the Board of Directors determines in good faith that the direct or indirect ownership of the common shares has become concentrated to an extent which would cause Capstead to fail to qualify as a REIT, the Company may redeem or repurchase, at fair market value, any number of common and/or preferred shares sufficient to maintain or bring such ownership into conformity with the Code. In addition, the Company may refuse to transfer or issue common and/or preferred shares to any person whose 22 CAPSTEAD MORTGAGE CORPORATION acquisition would result in Capstead being unable to comply with the requirements of the Code. Finally, the Charter provides that the Company may redeem or refuse to transfer any capital shares of Capstead necessary to prevent the imposition of a penalty tax as a result of ownership of such shares by certain disqualified organizations, including governmental bodies and tax-exempt entities that are not subject to tax on unrelated business taxable income. Comprehensive income is net income plus other comprehensive income (loss). Other comprehensive income (loss) consists of the change in unrealized gains and losses on debt securities classified as available-for-sale and amounts related to Derivatives held as cash flow hedges. As of December 31, 2003, the Accumulated other comprehensive income component of stockholder's equity consisted of $28.5 million in unrealized gains on debt securities and $259,000 in amounts related to cash flow hedging activities. The following provides information regarding comprehensive income (in thousands):

NOTE 13 -- EMPLOYEE AND DIRECTOR BENEFIT PLANS The Company sponsors stock plans to provide for the issuance of nonvested stock, stock options and other incentive-based stock awards (collectively, the "Plans"). As of December 31, 2003, the Plans provide for the issuance of up to an aggregate of 2,320,327 common shares of which 1,161,887 remain available for future issuance. Nonvested stock grants for 53,577 common shares were issued to employees on April 20, 2000 (grant date fair value $14.25 per share). These grants are subject to certain restrictions, including continuous employment, which generally lapse over five years. Costs associated with nonvested stock grants (measured by the fair value of the common shares on the date of grant multiplied by the number of shares granted) are recognized as compensation expense over the vesting period. Stock options granted and currently outstanding have terms and vesting requirements at the grant date of up to ten years and generally have been issued with strike prices equal to the quoted market prices of the Company's stock on the date of grant. Certain outstanding stock options previously granted to directors provide for the annual granting of dividend 23 CAPSTEAD MORTGAGE CORPORATION equivalent rights ("DERs") that permit the optionholder to obtain additional common shares at no cost based on formulas set forth in the Plans. The following tables provide information regarding stock option activity and option grants outstanding:

* In January 2003 and June 2001 significant capital was returned to the common stockholders via special dividend distributions resulting in recapitalizations of the Company. Accordingly, all existing options were cancelled and replaced with new option grants for an increased number of shares at a reduced exercise price that retained the same vesting and expiration characteristics as the cancelled grants such that each optionholder's economic position remained unchanged subsequent to the recapitalizations. The new grants are accounted for as non-compensatory.

* Includes related DER grants made to directors. * Weighted average exercise prices (adjusted for related DER grants) and weighted average lives of these significant option grants were $10.07 and seven years, and $27.00 and three years, respectively. Compensation costs for stock awards granted by the Company pursuant to APB25 totaled $127,000, $140,000, and $136,000 in 2003, 2002, and 2001, respectively. The effect described in NOTE 2 of determining compensation cost for stock options granted since the beginning of 1995 based upon the estimated fair value at the grant date consistent with the methodology prescribed under SFAS 123 was determined using a Black-Scholes option pricing model and, depending upon each individual option grant during the last three years, dividend yields of 12% to 15%, volatility factors of 38% to 40%, expected life assumptions of two to four years and risk-free rates of 1.8% to 4.6%. 24 CAPSTEAD MORTGAGE CORPORATION The Company also sponsors a qualified defined contribution retirement plan for all employees and a deferred compensation plan for certain of its officers. The Company matches up to 50% of a participant's voluntary contribution up to a maximum of 6% of a participant's compensation and may make additional contributions of up to another 3% of a participant's compensation. All Company contributions are subject to certain vesting requirements. Contribution expenses were $134,000, $96,000, and $47,000 in 2003, 2002, and 2001, respectively. NOTE 14 -- COMMITMENTS AND CONTINGENCIES During 1998, twenty-four purported class action lawsuits were filed against Capstead and certain of its officers alleging, among other things, that the defendants violated federal securities laws by publicly issuing false and misleading statements and omitting disclosure of material adverse information regarding the Company's business. In March 2003 the court granted the Company and named officers' motions to dismiss and entered an order dismissing the amended complaint and denying the plaintiffs' request to further amend their complaint. In November 2003, the plaintiffs' opportunity to appeal this dismissal to the Fifth Circuit Court of Appeals passed. With the dismissal of this case without appeal, the Company recovered from its insurance carrier a $500,000 deductible originally expensed in 1998 and 1999. This recovery was recorded in Other Revenue (expense) when received during the fourth quarter of 2003. NOTE 15 -- TRANSACTIONS WITH FORMER AFFILIATES Pursuant to a management contract entered into in April 2000, Fortress provided the services of its chairman to serve as Capstead's chairman and chief executive and of other individuals as necessary to perform support services for him. On July 22, 2003 Fortress' chairman resigned from his positions with Capstead and the management contract with Fortress was terminated. Under the terms of the contract, Fortress was entitled to a $375,000 base annual fee and participated with management and employees in an incentive fee program based on the Company's expected performance against predetermined benchmarks established by members of the Board of Directors independent of Fortress. Included in Other operating expense is $210,000, $375,000 and $375,000 of base fees paid to Fortress for services rendered during 2003 (through July 22nd), 2002 and 2001 respectively. See NOTE 6 for information regarding Fortress' involvement through its affiliate Brookdale in the acquisition and long-term leasing of senior living facilities acquired by Capstead in May 2002. 25 CAPSTEAD MORTGAGE CORPORATION NOTE 16 -- NET INTEREST INCOME ANALYSIS (UNAUDITED) The following summarizes interest income and interest expense and weighted average interest rates (dollars in thousands):

Changes in interest income and interest expense due to changes in interest rates versus changes in volume were as follows (in thousands):

* 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. 26 CAPSTEAD MORTGAGE CORPORATION NOTE 17 -- QUARTERLY RESULTS (UNAUDITED) Summarized quarterly results of operations were as follows (in thousands, except per share amounts).

NOTE 18 -- MARKET AND DIVIDEND INFORMATION (UNAUDITED) The New York Stock Exchange trading symbol for Capstead's common shares is CMO. There were 2,421 common stockholders of record at December 31, 2003. In addition, depository companies held common shares for 28,234 beneficial owners. The high and low sales prices and dividends declared on the common shares were as follows:

* On December 12, 2002 Capstead declared a special dividend of $7.19 per common share together with a regular quarterly dividend of $1.16 per common share that was paid January 21, 2003 to stockholders of record on December 31, 2002 (see NOTE 12). 27 CAPSTEAD MORTGAGE CORPORATION SELECTED FINANCIAL DATA (In thousands, except per share amounts)

NOTE: See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to Consolidated Financial Statements" for discussion of changes to the Company's operations that are expected to impact future operating results. (a) In May 2002 Capstead made its first direct investment in real estate, a portfolio of senior living facilities leased to a former affiliate. (b) Results in 2000 include losses on the sale of financial assets incurred with the modification of the Company's investment strategy to focus primarily on adjustable-rate financial assets. (c) Amounts have been adjusted for two 1-for-2 reverse common stock splits effective in July 2001 and May 2000, respectively. (d) The 2002 special dividend was a component of the $8.35 fourth quarter 2002 common dividend paid in January 2003 with a December 2002 record date. The 2001 special common dividend was paid in June 2001. Both special dividends were recorded as reductions to Paid-in Capital. (e) The Series C and D preferred shares were converted into common shares in May 2001 and December 2000, respectively. 28 CAPSTEAD MORTGAGE CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION OVERVIEW Capstead Mortgage Corporation ("Capstead" or the "Company") operates as a real estate investment trust ("REIT") earning income from investing in real estate-related assets on a leveraged basis and from other investment strategies. These investments primarily consist of, but are not limited to, residential adjustable-rate mortgage ("ARM") securities issued by government-sponsored entities, either Fannie Mae, Freddie Mac or Ginnie Mae ("Agency Securities"). The Company has also made limited investments in credit-sensitive commercial real estate-related assets, including the direct ownership of real estate. Management believes that such investments, when available at favorable prices and combined with the prudent use of leverage, can produce attractive risk-adjusted returns over the long term with relatively low sensitivity to changes in interest rates. From the beginning of 2001 and through June 2003, the Company experienced steadily declining mortgage securities portfolio balances primarily because of high levels of mortgage prepayments and a lack of compelling investment opportunities. Market conditions in the latter half of 2003 allowed for the acquisition of sufficient ARM securities at relatively attractive prices to offset portfolio runoff. In addition, prepayments moderated considerably, putting less pressure on portfolio balances. These trends continued into the first quarter of 2004. If available, the Company intends to continue pursuing the acquisition of attractively priced ARM securities, while also investigating other real estate-related opportunities. RISK FACTORS Under the captions "Effects of Interest Changes," "Risks Associated with Credit-Sensitive Investments," "Risks Associated with Owning Real Estate" and "Investment Company Act of 1940" are discussions of risk factors affecting Capstead's financial condition and results of operations that are an integral part of this discussion and analysis. Readers are strongly urged to consider these factors while reading this document. MANAGEMENT CHANGES Fortress Investment Group, LLC (together with its affiliates, "Fortress") was Capstead's largest stockholder, holding approximately 26% of the Company's outstanding common shares as recently as December 31, 2002. By July 2003, Fortress had sold its investment in Capstead and a management contract pursuant to which Fortress provided chairman and chief executive officer services was terminated. Paul M. Low, one of Capstead's founders and a long-time member of the Board of Directors, was appointed Chairman, and Andrew F. Jacobs, formerly Executive Vice President and Chief Financial Officer, was promoted to President and Chief Executive Officer and elected to serve on the Board of Directors. 29 CAPSTEAD MORTGAGE CORPORATION BOOK VALUE PER COMMON SHARE As of December 31, 2003, the Company's book value per common share was $6.67, a decline of $1.56 since December 31, 2002. Book value declined from the prior year because of dividend payments in excess of quarterly net income (approximately $0.22 per share) and, more significantly, a reduction in the aggregate unrealized gain on the Company's investments (most of which are debt securities carried at fair value with changes in fair value reflected in stockholders' equity) as a result of runoff caused by mortgage prepayments and lower underlying coupon interest rates on ARM securities. This unrealized gain can be expected to continue to decline with runoff and to fluctuate with changes in interest rates and market liquidity, and such changes will largely be reflected in book value per common share. Book value will also be affected by other factors, including common equity issuances, dividend distributions and depreciation charges on net-leased real estate; however, temporary changes in fair values of investments not carried at fair value on the Company's balance sheet generally will not affect book value. MORTGAGE SECURITIES AND SIMILAR INVESTMENTS As of December 31, 2003, mortgage securities and similar investments consisted primarily of ARM Agency Securities. Agency Securities are AAA-rated and are considered to have limited credit risk. Non-agency securities are private mortgage pass-through securities whereby the related credit risk of the underlying loans is borne by AAA-rated private mortgage insurers or by the Company ("Non-agency Securities"). Commercial mortgage-backed securitizations generally have senior, mezzanine and subordinate classes of bonds with the lower classes providing credit enhancement to the more senior classes. Commercial mortgage-backed securities ("CMBS") held by the Company at December 31, 2003 are mezzanine classes and therefore carry credit risk associated with the underlying pools of commercial mortgages that is mitigated by subordinate bonds held by other investors. Mortgage securities are financed under repurchase arrangements with investment banking firms pursuant to which specific securities are pledged as collateral. Should the Company acquire financial assets that are not mortgage-backed securities, loans with other parties, such as commercial banks, may be employed (see "Liquidity and Capital Resources"). Although having moderated considerably during the fourth quarter of 2003 and into early 2004, runoff caused by mortgage prepayments remains a significant challenge to earnings generated by the Company's mortgage securities. After experiencing portfolio declines to $2.0 billion by June 30, 2003 from $2.4 billion at December 31, 2002, during the latter half of 2003 the Company had the opportunity to acquire $441 million of primarily ARM Agency Securities at relatively attractive prices. This opportunity became available when long-term interest rates moved sharply higher during the third quarter in response to clear indications that the economy was recovering from a sustained period of economic weakness and the markets began anticipating that stronger economic growth would lead to an increase in inflation and force the Federal Reserve to begin raising short-term interest rates. By year-end, another $115 million of ARM securities was committed for first quarter 2004 settlement. These acquisitions were sufficient to replace runoff for the second half of 2003 and several months into 2004. In addition, Capstead transferred into this portfolio $146 million in high coupon fixed-rate collateral released from financed CMOs. The 30 CAPSTEAD MORTGAGE CORPORATION Company expects to earn improved financing spreads (the difference between yields earned on investments and the interest rates charged on related borrowings) than when financed by CMO bonds. Together these additions allowed for the sequential growth of the mortgage securities and other investment portfolio the last two quarters of 2003 after several years of steady declines, ending the year with a $2.2 billion portfolio. Prior to this third and fourth quarter activity, additions to this portfolio during 2003 were limited to $49 million of adjustable-rate collateral released from financed CMOs. Although the Company has had continued success subsequent to year-end acquiring additional ARM securities such that it expects further portfolio growth during the first quarter of 2004, there can be no assurance that attractively priced ARM securities will continue to be available. To the extent the proceeds of mortgage prepayments and other maturities are not reinvested or cannot be reinvested at a rate of return on invested capital at least equal to the return earned on previous investments, earnings and common dividends may decline. The future size and composition of the Company's investment portfolios will depend on market conditions, including levels of mortgage prepayments and the availability of attractively priced investments. The following yield and cost analysis illustrates results achieved during 2003 for components of the mortgage securities and similar investments portfolio and anticipated first quarter 2004 asset yields and borrowing rates based on portfolio composition and interest rates in effect on January 28, 2004 (the date fourth quarter 2003 results were released) (dollars in thousands):

(a) Basis represents the Company's investment before unrealized gains and losses. Actual asset yields, runoff rates, interest rates on borrowings and resulting financing spread are presented on an annualized basis. (b) Projected annualized yields for the first quarter of 2004 reflect ARM coupon resets and lifetime prepayment assumptions as adjusted for expected annualized prepayments for this quarter only, as of January 28, 2004. Actual yields realized in future periods will largely depend upon (i) changes in portfolio composition, (ii) ARM coupon interest rate resets, (iii) actual prepayments and (iv) any changes in lifetime prepayment assumptions. (c) The Company uses its liquidity to pay down borrowings. Return on assets is calculated on an annualized basis assuming the use of this liquidity to reduce borrowing costs (see "Utilization of Capital and Potential Liquidity"). 31 CAPSTEAD MORTGAGE CORPORATION Financing spreads (the difference between the yields earned on these investments and the rates charged on related borrowings) declined 64 basis points during 2003 to average 2.74% for the year. The overall yield earned on the portfolio averaged 3.97% in 2003, compared to an average yield of 5.17% earned the prior year. Yields on ARM securities fluctuate as coupon interest rates on underlying mortgage loans reset to reflect current interest rates and are expected to continue to decline in the coming quarters. For example, if interest rates stabilize at rates in effect January 28, 2004, the average yield on the portfolio could decline from the 3.40% projected yield for the first quarter of 2004 to 3.16% by the fourth quarter of 2004. Actual yields will depend on portfolio composition as well as fluctuations in, and market expectations for fluctuations in, interest rates and levels of mortgage prepayments. Average rates on related borrowings averaged a low 1.23% for the year having benefited from the action taken by the Federal Reserve to reduce the Federal Funds Rate by 25 basis points in June 2003. Borrowing rates averaged 1.79% during 2002. The Company's borrowing rates depend on actions by the Federal Reserve to change short-term interest rates, market expectations of future changes in short-term interest rates and the extent of changes in financial market liquidity. CMO COLLATERAL AND INVESTMENTS Since exiting the residential mortgage loan conduit business in 1995, Capstead has maintained finance subsidiaries with capacity to issue CMOs and other securitizations backed by residential mortgage loans. The last CMO issued by the Company was in 2000 and the Company does not currently anticipate issuing additional CMOs. Credit risk associated with pledged CMO collateral is borne by AAA-rated private mortgage insurers or by subordinated CMO bonds. With recent redemptions of previously issued CMOs, the Company no longer has credit risk held in the form of subordinated bonds associated with outstanding pledged CMO collateral. Most of the Company's securitizations were afforded financing accounting treatment with the related collateral recorded as pledged CMO collateral and the outstanding bonds recorded as CMO liabilities (referred to as "financed CMOs") while other securitizations were treated as sales transactions (referred to as "sold CMOs"). In recent years, the Company has exercised its right to redeem previously issued CMOs (referred to as "Clean-up Calls") selling some of the released collateral and holding the rest for investment. During 2003 the Company exercised Clean-up Calls related to eleven financed CMOs and four sold CMOs, selling $121 million of the released collateral and transferring another $195 million of collateral into the Non-Agency Securities portfolio. As of December 31, 2003, the Company holds clean-up call rights on only one of its six remaining CMOs. Consequently, additional significant gains from CMO redemptions are not expected to occur. CMO collateral and investments, net of related bonds, declined to $764,000 at December 31, 2003 from $8.6 million at year-end 2002, as a result of portfolio runoff and exercising Clean-up Calls as discussed above. Without the issuance of CMOs in which the Company retains residual interests, or the acquisition of other CMO investments, this portfolio is not expected to contribute significantly to operating results in future periods. 32 CAPSTEAD MORTGAGE CORPORATION REAL ESTATE HELD FOR LEASE In May 2002 Capstead acquired six "independent" senior living properties (wherein the operator of the facility provides most of the tenants little, if any, medical care) (the "Properties"). Concurrent with the acquisition of the Properties, the Company entered into a long-term "net-lease" arrangement (the "Lease") with Brookdale Living Communities, Inc., ("Brookdale"), under which Brookdale is responsible for the ongoing operation and management of the Properties. Brookdale, an owner, operator, developer and manager of senior living facilities, is a majority-owned affiliate of Fortress. The Lease has an initial term of 20 years and provides for two 10-year renewal periods. Beginning in May 2007, Brookdale will have the option of purchasing all of the Properties from Capstead at the greater of fair value or Capstead's original cost, after certain adjustments. Under the terms of the Lease, Brookdale is responsible for paying all expenses associated with operating the Properties, including real estate taxes, other government charges, insurance, utilities and maintenance, and an amount representing an attractive cash return on Capstead's equity in the Properties after payment of monthly debt service. In keeping with Capstead's strategy of reinvesting a portion of its capital into investments that can produce attractive returns over the long term with less sensitivity to changes in interest rates, any future changes in monthly debt service requirements are the responsibility of Brookdale under the terms of the Lease. The following table summarizes information about the Properties:

(a) IL refers to Independent Living units and AL refers to Assisted Living units. (b) As of December 31, 2003. CONTRACTUAL OBLIGATIONS The following table lists Capstead's contractual obligations, including related interest obligations through maturity, as of December 31, 2003 (in thousands):

33 CAPSTEAD MORTGAGE CORPORATION For variable-rate borrowings the interest component of these obligations is based on rates in effect at year-end. Payments due by period on CMOs reflect current expectations of mortgage prepayments on related pledged collateral and the exercise of Clean-up Calls. This presentation excludes acquisitions of financial assets and any other contractual obligations entered into after year-end. UTILIZATION OF CAPITAL AND POTENTIAL LIQUIDITY The Company's utilization of capital and potential liquidity as of December 31, 2003, adjusted for liquidity reserves, were as follows (in thousands):

(a) Assets are stated at carrying amounts on the Company's balance sheet. Potential liquidity is based on maximum borrowings available under existing uncommitted repurchase arrangements considering the fair value of related collateral as of December 31, 2003, adjusted separately for liquidity reserves. (b) Represents unrestricted cash and cash equivalents. (c) The fourth quarter 2003 common dividend was declared December 11, 2003 and paid January 21, 2004 to stockholders of record as of December 31, 2003. (d) Liquidity reserves reflect management's determination, as of the balance sheet date, of the level of capital necessary to hold in reserve to fund principal payments (that are not remitted to the Company for 25 to 45 days after any given month-end) and potential margin calls (requirements to pledge additional collateral or pay down borrowings caused by declines in market value of pledged assets) under stressed market conditions. The Company generally finances its mortgage securities and similar investments with well-established investment banking firms using repurchase arrangements and similar borrowings. Assuming potential liquidity is available, these borrowings can be increased or decreased on a daily basis to meet cash flow requirements and otherwise manage capital resources efficiently. CMO collateral is pledged to secure CMO bonds. Real estate held for lease is financed by long-term borrowings. Liquidity is affected by, among other things, changes in market value of assets pledged under borrowing arrangements, principal prepayments and general conditions in the investment banking, mortgage finance and real estate industries. Future levels of financial leverage will be dependent upon many factors, including the size and composition of the Company's investment portfolios (see "Liquidity and Capital Resources"). 34 CAPSTEAD MORTGAGE CORPORATION TAX CONSIDERATIONS OF DIVIDENDS PAID ON CAPSTEAD SHARES Preferred share dividend distributions for the last three years have consisted entirely of ordinary taxable income. Each common share dividend distribution (including the 2002 and 2001 special common dividend distributions) is allocated between ordinary taxable income, capital gain and return of capital based on the relative amounts of Capstead's taxable income (by category, after consideration of available capital loss carryforwards and allocations to preferred shares) to total distributions for each year. Stockholders should reduce the tax cost basis of their shares by the amount of return of capital distributions received, if any. Return of capital distributions received in excess of tax cost basis should be reported as capital gain. Due to the complex nature of the applicable tax rules, it is recommended that stockholders consult their tax advisors to ensure proper tax treatment of dividends received. The following table provides tax characteristics of Capstead's common share dividend distributions for the last three years:

* The indicated characterization percentage is applicable to each quarterly or special common dividend received with respect to a given tax year. This includes fourth quarter dividends declared prior to year-end with a December record date and paid in January of the following year in accordance with the Internal Revenue Code spillover distribution provision (IRC Section 875(b)(9)). Dividend characterization information for tax years prior to 2001 is available at www.capstead.com. 35 CAPSTEAD MORTGAGE CORPORATION RESULTS OF OPERATIONS Comparative net operating results (interest income or fee revenue, net of related interest expense and, in the case of real estate held for lease and CMO administration, related direct and indirect operating expense) by source were as follows (in thousands, except per share amounts):

* Capstead reports operating income per common share (a non-GAAP financial measure calculated excluding depreciation on real estate, gain on asset sales and CMO redemptions, and the dilutive effects of the Series B preferred shares) under the belief it provides investors with a useful supplemental measure of the Company's operating performance. Depreciation on real estate, although an expense deductible for federal income tax purposes and therefore an item that reduces Capstead's REIT distribution requirements, is added back to arrive at operating income because it is a noncash expense. Gains are excluded because they are considered non-operating in nature and the amount and timing of any such gains are dependent upon market conditions. Operating income per common share excludes the dilutive effects of the Series B preferred shares because it is not economically advantageous to convert these shares at the current market prices of both the common shares and Series B preferred shares (see "Comparison of Operating Income and Diluted Income per Common Share"). 2003 COMPARED TO 2002 The earning capacity of Capstead's financial asset portfolios is influenced by the overall size and composition of the portfolios, the relationship between short- and long-term interest rates (the "yield curve") and the extent the Company continues to invest its liquidity in these 36 CAPSTEAD MORTGAGE CORPORATION portfolios. Net margins on financial assets and related financing spreads have benefited significantly the past three years from actions taken by the Federal Reserve, particularly during 2001, to lower short-term interest rates, which resulted in significantly lower interest rates on the Company's borrowings. However, lower interest rates have also led to declining yields on the Company's adjustable-rate assets and declining portfolio balances primarily caused by higher mortgage prepayment rates. While financing spreads are expected to continue declining as yields on the Company's ARM securities continue resetting lower, the Company has had success recently in replacing runoff that, if it continues, should slow declines in net margins provided borrowing rates stay at current levels. See "Financial Condition - "Overview" and "Mortgage Securities and Similar Investments" for further discussion of the current operating environment and the Company's goals regarding redeploying capital made available by portfolio runoff. Agency Securities remained the primary contributor to operating results in 2003. However, the impact of lower yields and a significantly lower average outstanding portfolio was evident in current year results, which were significantly less than in 2002 despite lower borrowing rates. The average outstanding Agency Securities portfolio was $1.9 billion during 2003 compared to $2.6 billion during 2002. The portfolio yielded 3.88% during 2003 while borrowing rates averaged 1.17%, producing a financing spread of 2.71%. This compares with yields of 5.16% and borrowing rates of 1.75% for a spread of 3.41% in 2002. Conversely, Non-agency Securities contributed more to operating results during 2003 than in 2002, primarily because of the benefits of additional securities made available from the redemption of CMOs. The average outstanding portfolio was $163 million during 2003 compared to $91 million in 2002. The portfolio yielded 4.63% during 2003 while borrowing rates averaged 1.49%, producing a financing spread of 3.14%. This compares with yields of 5.62% and borrowing rates of 1.87% for a spread of 3.75% in 2002. CMBS and other commercial loans contributed less to operating results during 2003 than in 2002 primarily because of a lower average outstanding portfolio due largely to payoffs during 2003 of several positions held throughout all of 2002. The average outstanding portfolio was $114 million during 2003 compared to $192 million in 2002. The portfolio yielded 4.44% during 2003 while borrowing rates averaged 1.99% producing a financing spread of 2.45%. This compares with yields of 4.97% and borrowing rates of 2.44% for a spread of 2.53% in 2002. The CMO collateral and investments portfolio has declined significantly the last several years primarily because of high prepayments on the underlying pledged CMO collateral and the exercise of Clean-up Calls in which the Company redeemed the related bonds and either sold the released CMO collateral for gains or transferred it into the Non-agency Securities portfolio where it is held for investment. In May 2002 the Company made its first direct investment in real estate that is net-leased on a long-term basis. Under the terms of the Lease, changes in interest rates on the related debt are the responsibility of the lessee. Current year results were higher than in 2002 primarily because the properties were owned for a full year in 2003 compared to only eight months in 2002. Gain on asset sales and CMO redemptions in 2003 reflects a gain of $4.0 million on the sale of $121 million of released CMO collateral and a net gain of $545,000 on the redemption of CMO bonds related to $195 million in collateral held as Non-agency Securities 37 CAPSTEAD MORTGAGE CORPORATION upon release from the related indentures. The Company does not anticipate realizing significant additional gains from the redemption of previously issued securitizations. CMO administration revenue continues to trend lower primarily because of a declining portfolio of CMOs for which the Company provides administrative services. Since most of the CMOs the Company administered have been called, CMO administration is not expected to contribute significantly to operating results in future periods. Although earnings from overnight investments were significantly less in 2003, other revenue benefited from the recovery of a $500,000 insurance deductible related to the October 2003 dismissal of the 1998 purported stockholder class action lawsuit (see "NOTE 14" to the accompanying consolidated financial statements). On a combined basis, incentive fees paid to former affiliate and other operating expenses were considerably less during 2003 than in 2002. This reflects lower current year accruals for incentive fees primarily because of lower earnings and dividends and declines in book value caused largely by portfolio runoff. See "NOTE 2" to the accompanying consolidated financial statements and "Financial Condition - Management Changes." 2002 COMPARED TO 2001 Net margins on financial assets and related financing spreads benefited in 2002 from actions taken by the Federal Reserve during 2001 and again in November 2002 to lower short-term interest rates, which resulted in significantly lower interest rates on the Company's borrowings. However, lower interest rates also led to declining yields on the Company's adjustable-rate assets and declining portfolio balances primarily caused by higher mortgage prepayment rates. Agency Securities remained the primary contributor to operating results in 2002; however, the impact of lower yields and a significantly lower average outstanding portfolio led to lower results for 2002 despite lower borrowing rates. The average outstanding Agency Securities portfolio was $2.6 billion during 2002 compared to $4.0 billion during 2001. The portfolio yielded 5.16% during 2002 while borrowing rates averaged 1.75%, producing a financing spread of 3.41%. This compares with yields of 6.49% and borrowing rates of 4.18% for a spread of 2.31% in 2001. Non-agency Securities contributed less to operating results during 2002 than in 2001. The average outstanding portfolio was $91 million during 2002 compared to $87 million in 2001. The portfolio yielded 5.62% during 2002 while borrowing rates averaged 1.87%, producing a financing spread of 3.75%. This compares with yields of 7.58% and borrowing rates of 3.21% for a spread of 4.37% in 2001. CMBS and other commercial loans contributed more to operating results during 2002 than in 2001 primarily because of $200 million in portfolio additions since the fourth quarter of 2001. The average outstanding portfolio was $192 million during 2002 compared to $77 million in 2001. The portfolio yielded 4.97% during 2002 while borrowing rates averaged 2.44%, producing a financing spread of 2.53%. This compares with yields of 6.46% and borrowing rates of 4.47% for a spread of 1.99% in 2001. CMO collateral and investments contributed less to operating results primarily because of higher prepayments on the underlying pledged CMO collateral. In addition, the portfolio has declined with the exercise of Clean-up Calls in which the Company has retired related bonds and either sold released CMO collateral for gains or held it as Non-agency Securities. 38 CAPSTEAD MORTGAGE CORPORATION Real estate held for lease results reflected ownership of senior living facilities since May 2002. Revenue recognized through July 2002 consisted of accruals under a three-month rent concession. Cash lease payments began in August 2002. Gain on asset sales in 2002 reflected the sale of fixed-rate CMO collateral released from related CMOs pursuant to Clean-up Calls. In addition, a $15 million participation in a one-year secured commercial loan was sold for a gain of $1.9 million shortly after acquisition. This gain effectively accelerated into 2002 much of what would have been earned on this particular investment had it been held to maturity. CMO administration revenue trended lower primarily because a declining portfolio of CMOs for which the Company provides administrative services. Although earnings from overnight investments were significantly less in 2002, other revenue benefited from better than anticipated settlements of liabilities related to the Company's 1998 sale of its servicing operation. Incentive fee paid to former affiliate reflects the Company's performance against predetermined benchmarks. Incentive fees for 2002 were lower than in 2001 primarily because, excluding the effects of the July 2001 special dividend, book value remained fairly stable, while in 2001 book value increased substantially because of increases in market value of the Company's financial assets (see "NOTE 2" to the accompanying consolidated financial statements). LIQUIDITY AND CAPITAL RESOURCES Capstead's primary sources of funds are borrowings under repurchase arrangements and monthly principal and interest payments on mortgage securities and similar investments. Other sources of funds include proceeds from other borrowing arrangements, proceeds from asset sales, unrestricted payments received on real estate held for lease and proceeds from equity offerings. The Company generally uses its liquidity to pay down borrowings under repurchase arrangements to reduce borrowing costs and otherwise efficiently manage its capital. Because the level of these borrowings can be adjusted on a daily basis, the level of unrestricted cash and cash equivalents carried on the balance sheet is less important than the Company's potential liquidity available under its borrowing arrangements. The table included under "Financial Condition - Utilization of Capital and Potential Liquidity" and accompanying discussion illustrates additional funds potentially available to the Company as of December 31, 2003 as adjusted for liquidity reserves. The Company currently believes that it has ample liquidity and capital resources available for the acquisition of additional investments, repayments on borrowings and the payment of cash dividends as required for Capstead's continued qualification as a REIT. It is the Company's policy to remain strongly capitalized and conservatively leveraged. Borrowings under repurchase arrangements secured by Agency Securities and Non-agency Securities generally have maturities of less than 31 days. These borrowings totaled $1.9 billion at December 31, 2003. Capstead has uncommitted repurchase facilities with investment banking firms to finance these investments, subject to certain conditions. Interest rates on these borrowings are generally based on 30-day London Interbank Offered Rate ("LIBOR") and related terms and conditions are negotiated on a transaction-by-transaction basis. Amounts available to be borrowed under these arrangements are dependent upon the fair value of the securities pledged as collateral, which fluctuates with changes in interest 39 CAPSTEAD MORTGAGE CORPORATION rates, credit quality and liquidity conditions within the investment banking, mortgage finance and real estate industries. Borrowings under repurchase arrangements with investment banking firms secured by CMBS more closely match the interest rate adjustment features of these investments such that the Company anticipates it can earn more consistent financing spreads and, as a result, experience less interest rate volatility than experienced with investments in Agency Securities. These borrowings, which generally have longer initial maturities than borrowings secured by Agency Securities and may feature renewal options, totaled $70 million at December 31, 2003. Should Capstead make significant additional investments in credit-sensitive assets, it is anticipated that it will attempt to lessen interest rate volatility in a similar fashion or through the use of derivative financial instruments ("Derivatives") such as interest rate swaps. CMO borrowings totaled $167 million at December 31, 2003 and are secured by CMO collateral pledged to the related indentures. As such, recourse is limited to this collateral and therefore has a limited impact on Capstead's liquidity and capital resources. Mortgage prepayments and Clean-up Calls affect the maturity of each CMO series. With its acquisition of senior living properties in May 2002, Capstead assumed $19 million in fixed-rate mortgage financing from a commercial bank that matures in 2009 and $101 million in tax-exempt bond debt. In November 2002, the tax-exempt bonds were refunded with proceeds from issuing new 30-year adjustable-rate tax-exempt bonds. Under the terms of the Lease, changes in interest rates on this debt are the responsibility of the lessee and as such, have a limited effect on the Company's liquidity. Beginning in February 2004 the Company began selling common shares into the open market on a limited basis and such sales are expected to continue at least into the second quarter of 2004. During the month of February, Capstead raised $5.9 million of new common equity through the sale of 353,900 common shares at an average price of $16.67 per share, after expenses. The proceeds from these issuances are accretive to book value per share and, combined with Capstead's existing liquidity, are available to fund further acquisitions of ARM securities, if available at attractive prices, and increase the Company's flexibility in pursuing real estate-related opportunities. EFFECTS OF INTEREST RATE CHANGES INTEREST RATE SENSITIVITY ON OPERATING RESULTS The Company performs earnings sensitivity analysis using an income simulation model to estimate the effects that specific interest rate changes can reasonably be expected to have on future earnings. All financial assets and Derivatives held are included in this analysis. The sensitivity of components of Other revenue (expense) to changes in interest rates is included as well, although no asset sales are assumed. Because under the terms of the Lease the lessee is responsible for changes in related debt service requirements, earnings from the Company's investment in net-leased real estate are generally not affected by changes in interest rates. The model incorporates management assumptions regarding the level of mortgage prepayments for a given interest rate change using market-based estimates of prepayment speeds for purposes of amortizing investment and liability premiums and discounts. These assumptions are developed through a combination of historical analysis and future expected pricing behavior. 40 CAPSTEAD MORTGAGE CORPORATION As of December 31, 2003 and 2002, Capstead had the following estimated earnings sensitivity profile (dollars in thousands):

* 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. Income simulation modeling is the primary tool used by management to assess the direction and magnitude of changes in net margins on financial assets resulting from changes in interest rates. Key assumptions in the model include mortgage prepayment rates, changes in market conditions and management's financial capital plans. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net margins or precisely predict the impact of higher or lower interest rates on net margins. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and other changes in market conditions, management strategies and other factors. GENERAL DISCUSSION OF EFFECTS OF INTEREST RATE CHANGES Changes in interest rates may affect Capstead's earnings in various ways. Earnings currently depend, in part, on the difference between the interest received on mortgage securities and similar investments, and the interest paid on related borrowings, which are generally based on 30-day LIBOR. The resulting financing spread may be reduced or even turn negative in a rising short-term interest rate environment. Because the mortgage securities and similar investments portfolio consists primarily of ARM securities, the risk of rising short-term interest rates is offset to some extent by increases in the rates of interest earned on the underlying ARM loans, which reset once or twice a year based on underlying indices, subject to periodic and lifetime limits, referred to as caps. The Company's ARM securities featured the following average coupon rate, and average periodic and lifetime caps as of December 31, 2003 (dollars in thousands):

* Basis represents the Company's investment before unrealized gains and losses. 41 CAPSTEAD MORTGAGE CORPORATION Since only a portion of the ARM loans underlying these securities reset each month subject to periodic and lifetime caps, interest rates on borrowings can rise to levels that may exceed the interest rates on the underlying loans, contributing to lower or even negative financing spreads. At other times, declines in these indices during periods of relatively low short-term interest rates will negatively effect yields on ARM securities as the underlying ARM loans reset at lower rates. If declines in these indices exceed declines in the Company's borrowing rates, earnings would be adversely affected. The Company may invest in Derivatives from time to time as a hedge against rising interest rates on a portion of its short-term borrowings. At December 31, 2003, the Company did not own any Derivatives for this purpose. Another effect of changes in interest rates is that as long-term interest rates decrease, the rate of principal prepayments on mortgage loans underlying mortgage securities and similar investments generally increases. During periods of relatively low interest rates, prolonged periods of high prepayments can significantly reduce the expected life of these investments; therefore, the actual yields realized can be lower due to faster amortization of premiums. Further, to the extent the proceeds of prepayments are not reinvested or cannot be reinvested at a rate of interest at least equal to the rate previously earned on that capital, earnings may be adversely affected. There can be no assurance that suitable investments at attractive pricing will be available on a timely basis to replace runoff as it occurs or that the current composition of investments (consisting primarily of ARM Agency Securities) will be maintained. Capstead periodically sells assets, which may increase income volatility because of the recognition of transactional gains or losses. Such sales may become attractive as asset values fluctuate with changes in interest rates. At other times, asset sales may become prudent to shift the Company's investment focus. During periods of rising interest rates or contracting market liquidity, asset values can decline, leading to increased margin calls and reducing the Company's liquidity. A margin call means that a lender requires a borrower to pledge additional collateral to re-establish the agreed-upon ratio of the value of the collateral to the amount of the borrowing. If the Company is unable or unwilling to pledge additional collateral, lenders can liquidate the collateral under adverse market conditions, likely resulting in losses. RISKS ASSOCIATED WITH CREDIT-SENSITIVE INVESTMENTS Commercial mortgage assets may be viewed as exposing an investor to greater risk of loss than residential mortgage assets since such assets are typically secured by larger loans to fewer obligors than residential mortgage assets. Commercial property values and related net operating income are often subject to volatility, and net operating income may be sufficient or insufficient to cover debt service on the related mortgage loan at any given time. The repayment of loans secured by income-producing properties is typically dependent upon the successful operation of the related real estate project and the ability of the applicable property to produce net operating income rather than upon the liquidation value of the underlying real estate. Even when the current net operating income is sufficient to cover debt service, there can be no assurance that this will continue to be the case in the future. 42 CAPSTEAD MORTGAGE CORPORATION Additionally, commercial properties may not be readily convertible to alternative uses if such properties were to become unprofitable due to competition, age of improvements, decreased demand, regulatory changes or other factors. The conversion of commercial properties to alternate uses often requires substantial capital expenditures, which may or may not be available. The availability of credit for commercial mortgage loans may be dependent upon economic conditions in the markets where such properties are located, as well as the willingness and ability of lenders to make such loans. The availability of funds in the credit markets fluctuates and there can be no assurance that the availability of such funds will increase above, or will not contract below, current levels. In addition, the availability of similar commercial properties, and the competition for available credit, may affect the ability of potential purchasers to obtain financing for the acquisition of properties. This could affect the repayment of commercial mortgages. Credit-sensitive residential mortgage assets differ from commercial mortgage assets in several important ways yet can still carry substantial credit risk. Residential mortgage securities typically are secured by smaller loans to more obligors than CMBS, thus spreading the risk of mortgagor default. However, most of the mortgages supporting credit-sensitive residential securities are made to homeowners that do not qualify for Agency loan programs for reasons including loan size, financial condition, or work or credit history that may be indicative of higher risk of default than loans qualifying for such programs. As with commercial mortgages, in instances of default the Company may incur losses if proceeds from sales of the underlying residential collateral are less than the unpaid principal balances of the residential mortgage loans and related foreclosure costs. However, with residential mortgages this risk may be mitigated by various forms of credit enhancements including, but not limited to, primary mortgage insurance. Through the process of securitizing both commercial and residential mortgages, credit risk can be heightened or minimized. Senior classes in multi-class securitizations generally have first priority over cash flows from a pool of mortgages and, as a result, carry the least risk, highest investment ratings and the lowest yields. Typically, a securitization will also have mezzanine classes and subordinated classes. Mezzanine classes will generally have lower credit ratings, higher yields and may have average lives that are longer than the senior classes. Subordinate classes are junior in the right to receive cash flow from the underlying mortgages, thus providing credit enhancement to the senior and mezzanine classes. As a result, subordinated securities will have even lower credit ratings and higher yields because of the elevated risk of credit loss inherent in these securities. The availability of capital from external sources to finance investments in credit-sensitive commercial and residential mortgage assets may be diminished during periods of mortgage finance market illiquidity. Additionally, if market conditions deteriorate resulting in substantial declines in value of these assets, sufficient capital may not be available to support the continued ownership of such investments, requiring these assets to be sold at a loss. RISKS ASSOCIATED WITH OWNING REAL ESTATE The direct ownership of commercial real estate involves a number of risks. With its first acquisition of real estate, Capstead has attempted to mitigate these risks by entering into a long-term `net-lease' arrangement whereby the lessee is responsible for the ongoing 43 CAPSTEAD MORTGAGE CORPORATION operation and management of the properties and for paying all expenses associated with the operation of the properties. Although reduced by this net-lease arrangement, risks of ownership remain, including: - - The risk that changes in economic conditions or real estate markets may adversely affect the value of the properties. - - During inflationary periods, which are generally accompanied by rising interest rates, increases in operating costs and borrowing rates may be greater than increases in lessee revenues from operating properties. Over an extended period of time, this could result in lessee defaults. - - The risk that a deterioration of local conditions could adversely affect the ability of a lessee to profitably operate a property. For instance, an oversupply of senior living properties could hamper the leasing of senior living units at favorable rates. This could ultimately affect the value of the properties. - - Changes in tax, zoning or other laws could make properties less attractive or less profitable. - - An owner cannot be assured that lessees will elect to renew their leases when the terms expire. If a lessee does not renew its lease or otherwise defaults on its lease obligations, there is no assurance the owner can obtain a substitute lessee on acceptable terms. If the owner cannot obtain another qualified operator to lease a property, the owner may be required to modify the property for a different use, which may involve significant capital expenditures and delays in re-leasing the property. - - The risk that lessees will not perform under their leases, reducing the owner's income from the leases or requiring the owner to assume costs (such as real estate taxes, insurance, utilities and maintenance) that are the lessees' responsibility under net-leases. In the case of special-purpose real estate such as senior living facilities, compliance with licensing requirements could complicate or delay the transfer of operational control of such properties. This could lead to a significant cash flow burden for the owner to service the debt and otherwise maintain the properties. - - Net-leases generally require the lessee to carry comprehensive liability, casualty, workers' compensation and rental loss insurance. The required coverage is typical of the type and amount customarily obtained by an owner of similar properties. However, there are some types of losses, such as catastrophic acts of nature, for which insurance cannot be obtained at a commercially reasonable cost. If there is an uninsured loss or a loss in excess of insurance limits, the owner could lose both the revenues generated by the affected property and the capital invested in the property. The owner would, however, remain obligated to repay any mortgage indebtedness or other obligations related to the property. - - Investments in real estate are subject to various federal, state and local regulatory requirements including the Americans with Disabilities Act (the "ADA"). The ADA requires that public accommodations reasonably accommodate individuals with disabilities and that new construction or alterations be made to commercial facilities to conform to accessibility guidelines. Failure to comply with the ADA can result in injunctions, fines, damage awards to private parties and additional capital expenditures to remedy noncompliance. Existing requirements may change and compliance with 44 CAPSTEAD MORTGAGE CORPORATION future requirements may involve significant unanticipated expenditures. Although typically these expenditures would be the responsibility of the lessee under the terms of net-leases, if lessees fail to perform these obligations, the owner may be required to do so. - - Under federal, state and local environmental laws, the owner may be required to investigate and clean up any release of hazardous or toxic substances or petroleum products at its properties, regardless of its knowledge or actual responsibility, simply because of current or past ownership of the real estate. If unidentified environmental problems arise, the owner may have to make substantial payments, which could adversely affect cash flow and the ability to make distributions to stockholders. This is so because: 1. The owner may have to pay for property damage and for investigation and clean-up costs incurred in connection with the contamination. 2. The law may impose clean-up responsibility and liability regardless of whether the owner or operator knew of or caused the contamination. Even if more than one person is responsible for the contamination, each person who shares legal liability under environmental laws may be held responsible for all of the clean-up costs. 3. Governmental entities and third parties may sue the owner or operator of a contaminated site for damages and costs. In investigating the acquisition of real estate, environmental studies are typically performed to establish the existence of any contamination. In addition, net-leases generally require lessees to operate properties in compliance with environmental laws and to indemnify the owner against environmental liability arising from the operation of such properties. - - An owner may desire to sell a property in the future because of changes in market conditions or poor lessee performance or to avail itself of other opportunities. An owner may also be required to sell a property in the future to meet debt obligations or avoid a default. Unlike investments in mortgage securities, real estate cannot always be sold quickly, and there can be no assurance that the properties can be sold at a favorable price or that a prospective buyer will view existing lease or operating arrangements favorably. In addition, a property may require restoration or modification before it is sold. INVESTMENT COMPANY ACT OF 1940 The Investment Company Act of 1940, as amended (the "Investment Company Act"), exempts entities that are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on, and interests in, real estate. Capstead intends to conduct its business so as not to become regulated as an investment company under the Investment Company Act. If the Company fails to qualify for this exemption, its ability to use leverage would be substantially reduced and it would be unable to conduct its business as described herein. Under the current interpretation of the staff of the Securities and Exchange Commission ("SEC"), in order to qualify for this exemption a REIT must maintain at least 55% of its 45 CAPSTEAD MORTGAGE CORPORATION assets directly in qualifying real estate interests. Mortgage-backed securities that do not represent all of the certificates issued with respect to an underlying pool of mortgages ("Non-whole Pool Securities") may be treated as separate from the underlying mortgage loans and, thus, may not qualify for purposes of the 55% requirement. Therefore, the provisions of the Investment Company Act limit ownership of these mortgage-backed securities. In satisfying the 55% requirement under the Investment Company Act, a REIT may treat mortgage-backed securities issued with respect to an underlying pool to which it holds all issued certificates ("Whole Pool Securities") as qualifying real estate interests. If the SEC or its staff adopts a contrary interpretation of such treatment, the REIT could be required to sell a substantial amount of Non-whole Pool Securities or other non-qualified assets under potentially adverse market conditions. Further, in order to ensure continued qualifications for the exemption under the Investment Company Act, a REIT might be precluded from acquiring Non-whole Pool Securities even if their yield is higher than the yield of Whole Pool Securities. These factors may lower earnings. OTHER CRITICAL ACCOUNTING POLICIES Management's discussion and analysis of financial condition and results of operations is based upon Capstead's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the use of estimates and judgments that can affect the reported amounts of assets, liabilities (including contingencies), revenues and expenses as well as related disclosures. These estimates are based on available internal and market information and appropriate valuation methodologies believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the expected useful lives and carrying values of assets and liabilities which can materially affect the determination of net income and book value per common share. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following are critical accounting policies in the preparation of Capstead's consolidated financial statements that involve the use of estimates requiring considerable judgment: - - Amortization of Premiums and Discounts on Financial Assets and Borrowings - Premiums and discounts on financial assets and borrowings are recognized in earnings as adjustments to interest income or interest expense by the interest method over the estimated lives of the related assets or borrowings. For most of Capstead's financial assets estimates and judgments related to future levels of mortgage prepayments are critical to this determination. - - Fair Value and Impairment Accounting for Financial Assets - Most of Capstead's mortgage securities and similar investments portfolio and a small portion of its CMO collateral and investments portfolio are classified as held available-for-sale and recorded at fair value on the balance sheet with unrealized gains and losses recorded in stockholders' equity as a component of Accumulated other comprehensive income. As 46 CAPSTEAD MORTGAGE CORPORATION such, these unrealized gains and losses enter into the calculation of book value per common share. 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. Considerable judgment is required interpreting market data to develop estimated fair values, particularly in circumstances of deteriorating credit quality and market liquidity (see "NOTE 10" to the accompanying consolidated financial statements for discussion of how Capstead values its financial assets). - - Depreciation and Impairment Accounting for Real Estate held for Lease - Real estate is carried at cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of buildings, equipment and fixtures. If a significant adverse event or change in circumstances occurs, management would assess if the values of the Company's real estate properties have become impaired. If estimated operating cash flows (undiscounted and without interest charges) of a property over its remaining useful life are less than its net carrying value, the difference between net carrying value and fair value would be included in Other revenue (expense) as an impairment charge. Considerable judgment is required in determining useful lives of components of real estate properties and in estimating operating cash flows, particularly during periods of changing circumstances. FORWARD-LOOKING STATEMENTS This document contains "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995) that inherently involve risks and uncertainties. Capstead's actual results and liquidity can differ materially from those anticipated in these forward-looking statements because of changes in the level and composition of the Company's investments and unforeseen factors. Relative to the Company's investments in financial assets, these factors may include, but are not limited to, changes in general economic conditions, the availability of suitable investments, fluctuations in, and market expectations for fluctuations in, interest rates and levels of mortgage prepayments, deterioration in credit quality and ratings, the effectiveness of risk management strategies, the impact of leverage, liquidity of secondary markets and credit markets, increases in costs and other general competitive factors. Relative to direct investments in real estate, these factors may include, but are not limited to, lessee performance under lease agreements, changes in general as well as local economic conditions and real estate markets, increases in competition and inflationary pressures, changes in the tax and regulatory environment including zoning and environmental laws, uninsured losses or losses in excess of insurance limits and the availability of adequate insurance coverage at reasonable costs. 47 CAPSTEAD MORTGAGE CORPORATION COMPARISON OF OPERATING INCOME AND DILUTED INCOME PER COMMON SHARE The following table compares the calculation of operating income and operating income per common share to net income and diluted net income per common share (in thousands, except per share amounts):

* Reflects the Series B preferred shares as antidilutive prior to a July 2, 2001 change in conversion rates. DISCLOSURE AND CONTROL PROCEDURES AND RELATED CERTIFICATIONS As of December 31, 2003, an evaluation was performed under the supervision and with the participation of the Company's management, including the CEO and Chief Financial Officer ("CFO"), of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of December 31, 2003. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to December 31, 2003. Certifications by the CEO and CFO pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002 are included as exhibits to the Company's annual report on Form 10-K for the year ended December 31, 2003 which is available free of charge on its website at www.capstead.com. 48 CAPSTEAD MORTGAGE CORPORATION DIRECTORS ANDREW F. JACOBS President and Chief Executive Officer Member: Executive Committee GARY KEISER Private Investments PAUL M. LOW Chairman of the Board Chairman: Executive Committee Member: Audit and Governance & Nomination Committees MICHAEL G. O'NEIL Private Investments Chairman: Governance & Nomination Committee Member: Audit Committee HOWARD RUBIN Private Investments Chairman: Audit Committee Member: Compensation and Executive Committees MARK S. WHITING Managing Partner, Drawbridge Partners, LLC Chairman: Compensation Committee Member: Governance & Nomination Committee 49 CAPSTEAD MORTGAGE CORPORATION OFFICERS PAUL M. LOW Chairman of the Board ANDREW F. JACOBS President and Chief Executive Officer SENIOR VICE PRESIDENTS AMAR R. PATEL Asset and Liability Management PHILLIP A. REINSCH Chief Financial Officer and Secretary ROBERT R. SPEARS, JR. Asset and Liability Management VICE PRESIDENTS MICHAEL W. BROWN Asset and Liability Management and Treasurer D. CHRISTOPHER SIEBER Financial Accounting and Reporting ASSISTANT VICE PRESIDENTS LAURA CATHERINE DOOLITTLE Financial Accounting and Reporting BETHANY L. LEE Stockholder Relations 50 EX-21 5 d13093exv21.txt LIST OF SUBSIDIARIES OF THE COMPANY EXHIBIT 21 LIST OF SUBSIDIARIES OF CAPSTEAD MORTGAGE CORPORATION At December 31, 2003 the subsidiaries of Capstead Mortgage Corporation were as follows:

(1) CMC Properties, Inc. owns 100% of the indicated entity. (2) CMCP Properties, Inc. owns 99.99% of the indicated entity with the remainder held by CMCP - Texas, Inc. (3) CMCP - Florida SPE, Inc. owns 100% of the indicated entity. (4) CMC owns all of the issued and outstanding preferred stock. EX-23 6 d13093exv23.txt CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS EXHIBIT 23 CONSENT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report on Form 10-K of Capstead Mortgage Corporation of our report dated January 28, 2004, included in the 2003 Annual Report to Stockholders of Capstead Mortgage Corporation. We also consent to the incorporation by reference in the following registration statements and the related prospectuses, of our report dated January 28, 2004, with respect to the consolidated financial statements of Capstead Mortgage Corporation incorporated by reference in this Annual Report on Form 10-K for the year ended December 31, 2003: o Form S-8 (No. 33-40017); o Form S-3 (No. 33-62212); o Form S-8 (No. 33-53555); o Form S-3 (No. 333-03187); o Form S-8 (No. 333-12719); o Form S-3 (No. 333-26419) and Amendment No.1 thereto; o Form S-8 (No. 333-27215); o Form S-3 (No. 333-43169) and Amendment No.1 thereto; o Form S-3 (No. 333-63358); o Form S-3 (No. 333-68424) and Amendment No.1 thereto; and o Form S-3 (No. 333-112900). /s/ ERNST & YOUNG LLP Dallas, Texas March 3, 2004 EX-31.1 7 d13093exv31w1.htm CERTIFICATION PURSUANT TO SECTION 302(A) exv31w1

EXHIBIT 31.1

CAPSTEAD MORTGAGE CORPORATION
CERTIFICATION PURSUANT TO SECTION 302(a)
OF THE SARBANES-OXLEY ACT OF 2002

I, Andrew F. Jacobs, certify that:

1. I have reviewed this Annual Report on Form 10-K of Capstead Mortgage Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 3, 2004 By: /s/ ANDREW F. JACOBS
Andrew F. Jacobs
President and Chief Executive Officer

EX-31.2 8 d13093exv31w2.htm CERTIFICATION PURSUANT TO SECTION 302(A) exv31w2

EXHIBIT 31.2

CAPSTEAD MORTGAGE CORPORATION
CERTIFICATION PURSUANT TO SECTION 302(a)
OF THE SARBANES-OXLEY ACT OF 2002

I, Phillip A. Reinsch, certify that:

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 3, 2004 By: /s/ PHILLIP A. REINSCH
Phillip A. Reinsch
Senior Vice President and Chief Financial Officer

EX-32 9 d13093exv32.htm CERTIFICATION PURSUANT TO SECTION 906 exv32

EXHIBIT 32

CAPSTEAD MORTGAGE CORPORATION
CERTIFICATIONS PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

We, Andrew F. Jacobs, President and Chief Executive Officer, and Phillip A. Reinsch, Senior Vice President and Chief Financial Officer of Capstead Mortgage Corporation (the “Company”), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 that:

1. The Annual Report on Form 10-K of the Company for the annual period ended December 31, 2003 (the “Report”) fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78m); and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 3, 2004 By: /s/ ANDREW F. JACOBS
Andrew F. Jacobs
President and Chief Executive Officer

Date: March 3, 2004 By: /s/ PHILLIP A. REINSCH
Phillip A. Reinsch
Senior Vice President and Chief Financial Officer

A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

-----END PRIVACY-ENHANCED MESSAGE-----

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

(1)		Portions of the Registrant’s Annual Report to Stockholders for the year ended December 31, 2003 are incorporated by reference into Parts I, II and IV.

(2)		Portions of the Registrant’s definitive Proxy Statement, issued in connection with the 2004 Annual Meeting of Stockholders of the Registrant, are incorporated by reference into Part III.

	2.		Financial Statement Schedules — All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.

	*		Incorporated herein by reference from the Company’s Annual Report to Stockholders for the year ended December 31, 2003, filed herewith as Exhibit 13.

	3.		Exhibits:

	(1)		Incorporated by reference to the Company’s Registration Statement on Form S-8 (No. 33-40017) dated April 29, 1991

	(2)		Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1994

	(3)		Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 1997

	(4)		Incorporated by reference to the Company’s Registration Statement on Form S-3 (No. 333-63358) dated June 19, 2001

	(5)		Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001

	(6)		Incorporated by reference to the Company’s Post-Effective Amendment No. 1 to the Registration Statement on Form S-3 (No. 333-68424) dated December 17, 2003

	(7)		Incorporated by reference to the Company’s Registration Statement on Form S-3 dated February 17, 2004

	*		Filed herewith

(b)		Reports on Form 8-K:

		Current Report on Form 8-K dated October 22, 2003 to furnish the Company’s press release announcing third quarter results.

		Current Report on Form 8-K dated January 28, 2004 to furnish the Company’s press release announcing fourth quarter results, record date for annual meeting and common dividend schedule for 2004.

(c)		Exhibits — The response to this section of ITEM 15 is submitted as a separate section of this report.

(d)		Financial Statement Schedules — The response to this section of ITEM 15 is submitted as a separate section of this report.


	CAPSTEAD MORTGAGE CORPORATION Registrant
Date: March 3, 2004	By:	/s/ ANDREW F. JACOBS
		Andrew F. Jacobs
		President and Chief Executive Officer


Date: March 3, 2004	By:	/s/ PHILLIP A. REINSCH
		Phillip A. Reinsch
		Senior Vice President and Chief Financial Officer

1.		I have reviewed this Annual Report on Form 10-K of Capstead Mortgage Corporation;

2.		Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.		Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

	a)		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	b)		Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	c)		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

	d)		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

	a)		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	b)		Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

1.		The Annual Report on Form 10-K of the Company for the annual period ended December 31, 2003 (the “Report”) fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78m); and

2.		The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.