NOTE 6 — REPURCHASE ARRANGEMENTS AND SIMILAR BORROWINGS, INCLUDING INTEREST RATE HEDGING ACTIVITY

Capstead generally pledges its Mortgage securities and similar investments as collateral under uncommitted repurchase arrangements, the terms and conditions of which are negotiated on a transaction-by-transaction basis with commercial banks and other financial institutions, referred to as counterparties, when each borrowing is initiated or renewed. Repurchase arrangements entered into by the Company involve the sale and a simultaneous agreement to repurchase the transferred assets at a future date, typically with terms of 30 to 90 days, and are accounted for as financings. The Company maintains the beneficial interest in the specific securities pledged during the term of the repurchase arrangement and receives the related principal and interest payments. The amount borrowed is generally equal to the fair value of the assets pledged less an agreed-upon discount, referred to as a "haircut." In connection with the October 2011 bankruptcy of a lending counterparty, the Company received cash in lieu of the return of $8.3 million of its pledged collateral resulting in a loss of $62,000 on the effective sale of these bonds, which is included in Miscellaneous other revenue (expense) on the Statement of Income and Gain on asset sales on the Statement of Cash Flows. The basis in the bonds effectively sold is included in Proceeds from asset sales on the Statement of Cash Flows. Interest rates on these borrowings are fixed based on prevailing rates corresponding to the terms of the borrowings, and interest is paid at the termination of the repurchase arrangement at which time the Company may enter into a new repurchase arrangement at prevailing market rates with the same counterparty or repay that counterparty and negotiate financing with a different counterparty. In response to declines in fair value of pledged securities due to changes in market conditions or the publishing of monthly security pay down factors, lenders typically require the Company to post additional securities as collateral, pay down borrowings or establish cash margin accounts with the counterparties in order to re-establish the agreed-upon collateral requirements, referred to as margin calls. The maturity of structured financings is directly affected by prepayments on the related mortgage pass-through securities pledged as collateral and these financings are subject to redemption by the residual bondholders.

Repurchase arrangements and similar borrowings, classified by type of collateral and remaining maturities, and related weighted average interest rates as of the indicated year-end were as follows (dollars in thousands):


	*December 31, 2011*					*December 31, 2010*
*Collateral Type*	*Borrowings* *Outstanding*		*Average* *Rate*			*Borrowings* *Outstanding*		Average Rate
Borrowings with maturities of 30 days or less:
Agency Securities	$	10,754,835		0.37	%	$	7,554,225		0.30	%
Borrowings with maturities greater than 30 days:
Agency Securities (31 to 90 days)		594,283		0.32			235,000		0.33
Similar borrowings:
Collateral for structured financings		3,326		8.04			3,518		7.97

	$	11,352,444		0.37		$	7,792,743		0.31

Year-end rates adjusted for effects of related derivatives held as cash flow hedges				0.58					0.63

Average borrowings outstanding were lower than balances at year-end in 2011 and 2010 primarily due to portfolio growth and differences in the timing of portfolio acquisitions relative to portfolio runoff as illustrated below (dollars in thousands):


	*Year Ended*
	*December 31, 2011*					*December 31, 2010*
	*Borrowings* *Outstanding*		*Average* *Rate*			*Borrowings* *Outstanding*		Average Rate
Average borrowings and rates for the indicated year, adjusted for the effects of related derivatives held as cash flow hedges	$	10,059,807		0.56	%	$	7,050,395		0.66	%

To help mitigate exposure to higher short-term interest rates, Capstead uses currently-paying and forward-starting, one- and three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements that typically require interest payments for two-year terms. These derivatives are designated as cash flow hedges of the variability of the underlying benchmark interest rate of current and forecasted 30- to 90-day repurchase arrangements. This hedge relationship establishes a relatively stable fixed rate on related borrowings because the variable-rate payments received on the swap agreements largely offset interest accruing on the related borrowings, leaving the fixed-rate payments to be paid on the swap agreements as the Company's effective borrowing rate, subject to certain adjustments including the effects of measured hedge ineffectiveness and changes in spreads between variable rates on the swap agreements and actual borrowing rates.

Capstead entered into new currently-paying and forward-starting swap agreements hedging short-term interest rates totaling $3.0 billion during 2011 while swap agreements totaling $1.8 billion expired during the year. At December 31, 2011, the Company was a party to swap agreements hedging short-term interest rates with an average expiration of 15 months and the following characteristics (dollars in thousands):


*Quarter of* *Contract Expiration*	*Notional* *Amount*		*Average Fixed Rate* *Payment Requirement*
Currently-paying contracts:
First quarter 2012	$	800,000		1.10	%
Third quarter 2012		200,000		0.83
First quarter 2013		1,100,000		0.81
Second quarter 2013		700,000		0.96
Third quarter 2013		300,000		0.87
Fourth quarter 2013		800,000		0.78

		3,900,000		0.90
Forward-starting contracts:
First quarter 2014		200,000		0.60
Second quarter 2014		400,000		0.51


	$	4,500,000

In addition to swap agreements hedging short-term interest rates, in 2010 the Company entered into three forward-starting three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements with notional amounts totaling $100 million, average fixed rates of 4.09% that begin in 2015 and 2016 and 20-year terms coinciding with the floating-rate terms of the Company's Unsecured borrowings. These derivatives are designated as cash flow hedges of the variability of the underlying benchmark interest rate associated with the floating-rate terms of these long-term borrowings (see NOTE 7).

Interest rate swap agreements are measured at fair value on a recurring basis primarily using Level Two Inputs in accordance with "Fair Value Measurements and Disclosures" ("ASC 820"). In determining fair value estimates for these derivatives, the Company utilizes the standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts based on expected future interest rates derived from observable market interest rate curves. The Company also incorporates both its own nonperformance risk and its counterparties' nonperformance risk in determining the fair value of its interest rate swap derivatives. In considering the effect of nonperformance risk, the Company considered the impact of netting and credit enhancements, such as collateral postings and guarantees, and has concluded that counterparty risk is not significant to the overall valuation of these agreements. Included in the Accumulated other comprehensive income component of Stockholders' equity are unrealized losses on Derivatives held as cash flow hedges of $30.2 million and $6.5 million as of December 31, 2011 and 2010, respectively.

The following tables include fair value and other related disclosures regarding all derivatives held as of and for the indicated periods (in thousands):


	Location in Balance Sheet			December 31, 2011			December 31, 2010
*Balance sheet-related*
Interest rate swap agreements in a gain position (an asset) related to:
Repurchase arrangements and similar borrowings		^(a	⁾	$	617		$	734
Unsecured borrowings		^(a	⁾		–			8,863
					617			9,597
Interest rate swap agreements in a loss position (a liability) related to:
Repurchase arrangements and similar borrowings		^(a	⁾		(15,691	)		(16,337	)
Unsecured borrowings		^(a	⁾		(15,657	)		–
Related net interest payable		^(b	⁾		(10,023	)		(9,847	)

				$	(40,754	)	$	(16,587	)

(a)

The fair value of derivatives with realized and unrealized gains are aggregated and recorded as an asset on the face of the balance sheet separately from the fair value of derivatives with realized and unrealized losses that are recorded as a liability. The amount of unrealized losses that will be recognized in the statement of income over the next twelve months in the form of fixed- and variable-rate swap payments in excess of current market rates totaled $6.6 million at December 31, 2011.

(b)

Included in "Accounts payable and accrued expenses" on the face of the balance sheet.

Interest paid on Repurchase arrangements and similar borrowings, including related swap agreement cash flows, totaled $55.2 million, $56.3 million and $135.0 million during 2011, 2010 and 2009, respectively.


	*Location of* Gain or (Loss) Recognized in *Net Income*
		*December 31*
		*2011*			*2010*			*2009*
*Income statement-related*
Components of effect on interest expense:
Amount of gain (loss) reclassified from AOCI:
Effective portion of active positions		$	(28,066	)	$	(27,554	)	$	(56,585	)
Effective portion of terminated positions			–			8			(1,242	)

			(28,066	)		(27,546	)		(57,827	)
Amount of gain (loss) recognized (ineffective portion)			(827	)		(140	)		(1,148	)

Increase in interest expense and decrease in Net income as a result of the use of derivatives	^(a)	$	(28,893	)	$	(27,686	)	$	(58,975	)

*Other comprehensive income-related*
Amount of loss recognized in other comprehensive income (loss) (effective portion)		$	(51,751	)	$	(27,587	)	$	(16,709	)

(a)

Included in "Interest expense: Repurchase arrangements and similar borrowings" on the face of the statement of income.