NOTE 12 ¾ COMPENSATION PROGRAMS

The compensation committee of Capstead’s board of directors (the “Committee”) administers all compensation programs for employees including salaries, short- and long-term incentive compensation, including equity-based awards, as well as other benefit programs. After reviewing existing programs and practices and soliciting feedback from investors during 2013, the Committee made a number of important changes that became effective in 2013 and early 2014. The most prominent changes involved replacing an absolute return-based, discretionary bonus program and an absolute return-based stock award program with largely nondiscretionary and formulaic, target-based annual and long-term incentive compensation programs for key executives with multiple, pre-established performance goals and defined threshold, target and maximum awards as a percentage of base salary.

In May 2014 stockholders approved the Amended and Restated 2014 Flexible Incentive Plan, which provides for the issuance of up to five million shares of common stock pursuant to equity-based awards as well as other incentive awards that recognize the creation of value for stockholders and promote the Company’s long-term growth and success. At December 31, 2014, the Plan had 4,927,763 shares of common stock remaining available for future issuances.

Short-Term Incentive Compensation Programs

Effective June 30, 2013, the Committee terminated the absolute return-based, discretionary bonus program and adopted the new annual incentive compensation program that included relative performance metrics measured against the Company’s peers in the mortgage REIT industry as well as the attainment of individual goals and objectives for key executives. The relative performance metrics used were based on relative economic return (change in book value plus dividends) and relative operating efficiency (operating expenses divided by Unsecured borrowings and Stockholders’ equity), calculated for the full year and prorated for the six month period during which the program was effective in 2013.

Under this new program, each performance metric is assigned a weighting and the Company’s performance relative to each metric is calculated separately. No awards can be earned for performance below the defined threshold returns and awards are capped for performance above the defined maximum return levels. For 2014 the program was modified to add an absolute economic return performance metric which measures performance against defined return levels. Included in Accounts payable and accrued expenses at December 31, 2014 are annual incentive compensation accruals for all employees totaling $1.4 million. Recognized in Short-term incentive compensation are $1.2 million, $2.8 million and $4.1 million related to annual incentive compensation for all employees during 2014, 2013 and 2012, respectively.

The Committee administers an additional performance-based short-term incentive compensation program for key executives that provides for quarterly cash payments equal to per share dividends declared on Capstead’s common stock multiplied by a notional amount of non-vesting or “phantom” shares of common stock (“Dividend Equivalent Rights” or “DERs”). DERs only represent the right to receive the same cash distributions that the Company’s common stockholders are entitled to receive during the term of the grants, subject to certain conditions, including continuous service. In December 2014 the Committee extended the term of the 654,000 outstanding DERs to December 31, 2015. Included in Accounts payable and accrued expenses are fourth quarter 2014 DERs distribution amounts totaling $222,000 that were paid in January 2015. Recognized in Short-term incentive compensation are $889,000, $811,000 and $914,000 related to the DERs program during 2014, 2013 and 2012, respectively.

Long-term Equity-based Awards – Performance-based RSUs

The Committee adopted the new performance-based long-term incentive compensation program for key executives in December 2013. The program provides for the grant of performance-based RSUs that are convertible into common shares following three-year performance periods, contingent upon whether, and to what extent, defined performance levels established for certain relative and absolute return performance metrics are met or exceeded. The relative return metrics measure the Company’s performance against its peers in the mortgage REIT industry on the basis of relative economic return and relative total stockholder return (change in stock price plus reinvested dividends). The absolute economic return metric measures performance against defined return levels. For conversion purposes, each performance metric is assigned a weighting and the Company’s performance relative to each metric is calculated separately. The actual number of shares of common stock the units can convert into for each of the metrics, if any, can range from one-half of a share per unit if that metric’s minimum threshold of performance is met, to two shares per unit if the related maximum performance threshold is met or exceeded, adjusted for the weighting assigned to the metric. If a metric’s minimum performance threshold is not met, no shares are issuable under that metric. Dividends accrue from the date of grant and will be paid in cash when the units convert into shares of common stock based on the number of shares ultimately issued, if any.

Pursuant to this program, in January 2015 and December 2013 the Committee granted 247,512 and 242,505 RSUs with three-year performance periods ending December 31, 2017 and 2016, respectively. Initial grant date fair values of $8.83 and $12.45 were assigned to each unit of the January 2015 and December 2013 grants, respectively. These initial fair values imply compensation costs of $2.2 million and $3.0 million, respectively, to be recognized as expense over the three-year performance periods assuming performance levels estimated at issuance are achieved and there are no forfeitures. During 2014 the three-year compensation cost estimate for the December 2013 grant was reduced to $1.7 million, or $7.21 per unit, due to lowered expectations for attainment of certain nonmarket-based performance metrics and recognized in Long-term incentive compensation is $582,000 related to the first year of this grant’s three-year performance period. Included in Common Stock dividends payable at December 31, 2014 and 2013 are estimated dividends payable pertaining to these awards of $213,000 and $75,000, respectively.

Long-term Equity-based Awards – Stock Awards

Under an absolute return performance-based stock award program terminated in 2013, the Committee granted common stock awards to all employees with staggered three-year vesting periods. These awards vest if annualized returns in excess of established return levels are generated during three-year measurement periods. Vesting can be deferred and a new three-year measurement period established to include the subsequent year, up to and including the seventh calendar year after the year of grant. Any remaining unvested awards issued under this program will expire if the required returns are not generated for the final three-year measurement period. Grants under this program for 114,423, 121,026 and 67,599 shares vested during 2014, 2013 and 2012, respectively. Average grant date fair values for these grants were $13.31, $12.01 and $10.18, respectively. Grants for another 125,221 shares with an average grant date fair value of $12.58 vested in February 2015 pertaining to initial measurement periods ending December 31, 2014. Grants for 133,571 and 69,849 shares with average grant date fair values of $12.17 and $11.67 will vest in January of 2016 and 2017, respectively, if annualized returns in excess of established return levels are generated during these grants’ initial measurement periods.

In December 2014 and 2013 respectively, the Committee granted service-based stock awards for 37,237 and 35,703 shares of common stock with grant date fair values of $12.47 and $12.34 to employees that weren’t awarded RSUs. These awards vest January 2, 2018 and January 2, 2017, respectively. In January 2014 the remaining 22,164 shares associated with 2007 service-based stock awards issued to all employees vested. As a component of the Company’s director compensation program, directors are granted stock awards annually upon election or re-election to the board of directors that vest approximately one year from issuance. In July 2014, director stock awards for 35,000 shares with a grant date fair value of $13.16 were granted that vest in July 2015. In April 2014, director grants awarded in 2013 for 28,000 shares with a grant date fair value of $13.02 vested.

Performance-based and service-based stock award activity for year ended December 31, 2014 is summarized below:

	Number of Shares			Weighted Average Grant Date Fair Value
Unvested stock awards outstanding at beginning of year		528,931		$	12.51
Grants		72,237			12.80
Vestings		(164,587	)		13.23
Unvested stock awards outstanding at end of year		436,581			12.29

During 2014, 2013 and 2012, the Company recognized in Long-term incentive compensation $1.5 million, $1.8 million and $1.9 million, respectively, related to amortization of the grant date fair value of employee performance-based and service-based stock awards. The amounts amortized for these periods assumed that performance metrics, if applicable, would continue to be met for related initial measurement periods. In addition, the Company recognized in Other general and administrative expense $315,000, $387,000 and $362,000 related to amortization of the grant date fair value of service-based director stock awards during 2014, 2013 and 2012, respectively. Unrecognized compensation expense for unvested stock awards totaled $2.2 million as of December 31, 2014, to be expensed over a weighted average period of 1.5 years (assumes minimal employee and director attrition and, if applicable, absolute return performance metrics being met for related initial measurement periods).

All service-based stock awards receive dividends on a current basis without risk of forfeiture if the related awards do not vest. Outstanding performance-based stock awards defer the payment of dividends accruing between the grant dates and the end of related performance periods. If these awards do not vest, the related accrued dividends will be forfeited. Included in Common stock dividend payable at December 31, 2014 and 2013 are estimated dividends payable pertaining to these awards totaling $1.4 million and $1.2 million, respectively.

Long-term Equity-based Awards – Option Awards

Option awards currently outstanding have ten-year contractual terms from the grant date and were issued with strike prices equal to the quoted market prices of Capstead’s common shares on the dates of grant, all of which were prior to 2010. The fair value of option awards was estimated on the dates of grant using a Black-Scholes option pricing model and expensed over vesting periods that ended prior to 2012. Option award activity for the year ended December 31, 2014 is summarized below:

	Number of Shares			Weighted Average Exercise Price
Option awards outstanding at beginning of year		77,500		$	11.75
Expirations		(10,000	)		14.41
Exercises		(27,500	)		10.63
Option awards outstanding at end of year		40,000			11.86

All outstanding option awards are exercisable at December 31, 2014. These awards have a weighted average remaining contractual term of 3.5 years and an aggregate intrinsic value of $26,000. The total intrinsic value of option awards exercised was $67,000, $26,000 and $620,000 during 2014, 2013 and 2012, respectively.

Other Benefit Programs

Capstead sponsors a qualified defined contribution retirement plan for all employees and a nonqualified deferred compensation plan for certain of its executives. In general the Company matches up to 50% of a participant’s voluntary contribution up to a maximum of 6% of a participant’s base salary and annual incentive compensation payments and makes discretionary contributions of up to another 3% of such compensation regardless of participation in the plans. Company contributions are subject to certain vesting requirements that have been met by nearly all of Capstead’s current employees. During 2014, 2013 and 2012, the Company recognized in Salaries and benefits $258,000, $320,000 and $406,000 related to contributions to these plans, respectively.