NOTE 4 ¾ RESIDENTIAL MORTGAGE INVESTMENTS

Residential mortgage investments classified by collateral type and interest rate characteristics as of the indicated dates were as follows (dollars in thousands):

	Unpaid Principal Balance		Investment Premiums		Amortized Cost Basis		Carrying Amount ^(a)		Net WAC ^(b)			Average Yield^(b⁾
September 30, 2014
Agency Securities:
Fannie Mae/Freddie Mac:
Fixed-rate	$	1,717	$	5	$	1,722	$	1,724		6.64	%		6.17	%
ARMs		10,377,592		334,371		10,711,963		10,948,745		2.53			1.62
Ginnie Mae ARMs		2,660,875		92,454		2,753,329		2,764,458		2.65			1.50
		13,040,184		426,830		13,467,014		13,714,927		2.56			1.60
Residential mortgage loans:
Fixed-rate		1,896		2		1,898		1,898		6.97			5.76
ARMs		3,373		14		3,387		3,387		3.86			2.89
		5,269		16		5,285		5,285		4.97			3.84
Collateral for structured financings		2,035		34		2,069		2,069		8.10			7.64
	$	13,047,488	$	426,880	$	13,474,368	$	13,722,281		2.56			1.60
December 31, 2013
Agency Securities:
Fannie Mae/Freddie Mac:
Fixed-rate	$	2,158	$	6	$	2,164	$	2,167		6.67	%		6.47	%
ARMs		10,675,620		343,452		11,019,072		11,231,057		2.58			1.76
Ginnie Mae ARMs		2,145,639		74,396		2,220,035		2,233,495		2.64			1.64
		12,823,417		417,854		13,241,271		13,466,719		2.59			1.74
Residential mortgage loans:
Fixed-rate		2,633		3		2,636		2,636		6.99			5.63
ARMs		4,244		18		4,262		4,262		3.81			3.35
		6,877		21		6,898		6,898		5.03			4.20
Collateral for structured financings		2,220		37		2,257		2,257		8.09			7.68
	$	12,832,514	$	417,912	$	13,250,426	$	13,475,874		2.59			1.74

(a)	Includes unrealized gains and losses for residential mortgage investments classified as available-for-sale (see NOTE 10).

(b)

Net WAC, or weighted average coupon, is the weighted average interest rate of the mortgage loans underlying the indicated investments net of servicing and other fees as of the indicated balance sheet date. Net WAC is expressed as a percentage calculated on an annualized basis on the unpaid principal balances of the mortgage loans underlying these investments. Average yield is presented for the quarter then ended, and is based on the cash component of interest income expressed as a percentage calculated on an annualized basis on average amortized cost basis (the “cash yield”) less the effects of amortizing investment premiums. Investment premium amortization is determined using the interest method and incorporates actual and anticipated future mortgage prepayments.

Because of federal government support for the GSEs, Agency Securities are considered to have limited, if any, credit risk. Residential mortgage loans held by Capstead were originated prior to 1995 when the Company operated a mortgage conduit and the related credit risk is borne by the Company. Collateral for structured financings consists of private residential mortgage securities that are backed by loans obtained through this mortgage conduit and are pledged to secure repayment of related structured financings. Credit risk for these securities is borne by the related bondholders. The maturity of Residential mortgage investments is directly affected by prepayments of principal on the underlying mortgage loans. Consequently, actual maturities will be significantly shorter than the portfolio’s weighted average contractual maturity of 289 months.

Fixed-rate investments consist of residential mortgage loans and Agency Securities backed by residential mortgage loans with fixed rates of interest. Adjustable-rate investments generally are ARM Agency Securities backed by residential mortgage loans that have coupon interest rates that adjust at least annually to more current interest rates or begin doing so after an initial fixed-rate period. After the initial fixed-rate period, if applicable, mortgage loans underlying ARM securities typically either (i) adjust annually based on specified margins over the one-year Constant Maturity U.S. Treasury Note Rate (“CMT”) or the one-year London interbank offered rate (“LIBOR”), (ii) adjust semiannually based on specified margins over six-month LIBOR, or (iii) adjust monthly based on specified margins over indices such as one-month LIBOR, the Eleventh District Federal Reserve Bank Cost of Funds Index, or over a rolling twelve month average of the one-year CMT index, usually subject to periodic and lifetime limits, or caps, on the amount of such adjustments during any single interest rate adjustment period and over the contractual term of the underlying loans.

Capstead classifies its ARM securities based on each security’s average number of months until coupon reset (“months to roll”). Months to roll is an indicator of asset duration which is a measure of market price sensitivity to interest rate movements. A shorter duration generally indicates less interest rate risk. Current-reset ARM securities have months to roll of less than 18 months while longer-to-reset ARM securities have months to roll of 18 months or greater. As of September 30, 2014, the average months to roll for the Company’s $7.61 billion (amortized cost basis) in current-reset ARM securities was 6.2 months while the average months-to-roll for the Company’s $5.86 billion (amortized cost basis) in longer-to-reset ARM securities was 39.8 months.