NOTE 9 — COMPENSATION PROGRAMS

The compensation committee of Capstead’s board of directors (the “Committee”) administers all compensation programs for employees including salaries and related programs, annual incentive compensation and long-term equity-based awards, as well as other benefit programs.

Performance-based Cash Compensation Program to Augment Base Salaries

In 2008 the Committee began implementing a performance-based cash compensation program designed to introduce a variable component to the base compensation for executive officers. This program provides for payments equal to the per share dividend declared on the Company’s common stock multiplied by a notional amount of non-vesting or “phantom” common shares (“Dividend Equivalent Rights”). Dividend Equivalent Rights are not attached to any stock or option awards and only have 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 July 2012, the Committee granted an additional 72,000 Dividend Equivalent Rights that expire on July 1, 2015. In addition, the Committee extended the expiration of previous grants by one year such that all grants expire on July 1, 2015. Dividend Equivalent Rights issued and outstanding and the related compensation costs for the quarter and nine months ended September 30, 2012 were as follows:


*Month of* *Grant*	Total Grant		Quarter Ended September 30, 2012		Nine Months Ended September 30, 2012
July 2008		225,000	$	81,000	$	268,000
July 2009		225,000		81,000		268,000
July 2010		60,000		21,000		71,000
August 2011		72,000		26,000		85,000
July 2012		72,000		26,000		26,000

			$	235,000	$	718,000

Annual Incentive Compensation

To provide employees with an appropriate performance-based annual incentive compensation opportunity, each year the Committee approves an incentive formula designed to create an incentive pool to serve as a guideline for the award of annual incentive compensation that is directly linked with the performance of the Company. The formula adopted accomplishes this by establishing an incentive pool equal to a percentage participation in the Company’s earnings in excess of a pre-established performance threshold subject to a maximum amount, or cap, available to be paid in any one year. Notwithstanding the calculated amount of the incentive pool, the Committee retains complete discretion to determine (i) the amount actually awarded, (ii) its allocation between executive officers and other employees, and (iii) the form of payment (e.g., cash or equity awards).

The current formula for the incentive pool is based on a 10.0% participation in annual earnings, in excess of a benchmark amount established by multiplying average long-term investment capital by the greater of 10.0%, or the average 10-year U.S. Treasury rate plus 200 basis points, subject to a cap of 50 basis points multiplied by average long-term investment capital. Annual earnings for formula purposes is defined as Net income excluding (i) Incentive compensation, (ii) any gains or losses from asset sales or writedowns, including impairment charges, and (iii) interest on Unsecured borrowings, net of equity in the earnings of related statutory trusts reflected in the balance sheet as Investments in unconsolidated affiliates. Average long-term investment capital for formula purposes is defined as average Unsecured borrowings, net of related investments in statutory trusts, and average Stockholders’ equity, excluding (i) Accumulated other comprehensive income, (ii) incentive compensation accruals, (iii) certain gains or losses from asset sales or writedowns, and (iv) interest accruals on Unsecured borrowings. Included in Accounts payable and accrued expenses are annual incentive compensation accruals totaling $3.6 million and $5.7 million at September 30, 2012 and December 31, 2011, respectively.

Long-term Equity-based Awards

The Company sponsors equity-based award plans to provide for the issuance of stock awards, option awards and other long-term equity-based awards to directors and employees (collectively, the “Plans”). At September 30, 2012, the Plans had 829,668 common shares remaining available for future issuance.

In 2008 the Company implemented a performance-based stock award program in lieu of its previous practice of issuing service-based awards to employees. As this program is currently configured, the first 50% of awards granted each year vest provided certain performance criteria pertaining to a three-year measurement period that starts at the beginning of the following calendar year are met. The remaining 50% vests provided performance criteria pertaining to a three-year measurement period beginning one year later are met. If the performance criteria are not met at the end of a three-year measurement period, vesting will be deferred and a new three-year measurement period will be established to include the subsequent year, up to and including the seventh calendar year after the year of grant. Any remaining unvested awards will expire if the performance criteria for the final three-year measurement period are not met. The performance criteria establishes an annualized threshold return on the Company’s long-term investment capital, subject to certain adjustments, that must be exceeded for the awards to vest equal to the greater of 8.0% or the average 10-year U.S. Treasury rate plus 200 basis points. The following table includes performance-based stock awards issued to employees with related measurement period information at September 30, 2012:


						*Final*		*Remaining Shares with*
	*Grant Date*		*Total*			*Measurement*		*Initial Measurement Periods*
*Year of*	*Fair Value*		*Original*			*Period Ends*		*Ending December 31*
*Grant*	*Per Share*		*Grants*			*December 31*		*2012*		*2013*		*2014*		*2015*
2008	$	10.18		140,658	*		2015		67,595		—		—		—
2009		14.33		110,917			2016		55,043		55,035		—		—
2010		12.44		128,766			2017		—		64,087		64,077		—
2011		12.72		132,490			2018		—		—		66,247		66,243

*	The performance criteria for the first three-year measurement period ending December 31, 2011 was met resulting in the vesting of 67,599 shares associated with the first 50% of this grant.

The following table includes service-based stock awards issued to directors and employees with related vesting and forfeiture information (subject to certain restrictions, principally continuous service), at September 30, 2012:


	*Grant Date*		*Total*						*Remaining Shares*
*Year of*	*Fair Value*		*Original*		*As of December 31, 2011*				*Scheduled to Vest During:*
*Grant*	*Per Share*		*Grants*		*Vested*		*Forfeited*		*2012*			*2013*		*2014*
2007	$	12.93		156,000		76,009		12,499		22,498	*		22,497		22,497
2008		12.87		6,000		6,000		—		—			—		—
2009		11.39		6,000		6,000		—		—			—		—
2010		11.64		12,000		12,000		—		—			—		—
2011		13.23		24,000		—		—		24,000	*		—		—
2012		13.59		29,000		—		—		—			29,000		—

*	The 2007 grant shares vested in January 2012 and the 2011 grant shares vested in April 2012.

Performance- and service-based stock award activity for the nine months ended September 30, 2012 is summarized below:


	*Number of* *Shares*			*Weighted Average* *Grant Date* *Fair Value*
Unvested stock awards outstanding at December 31, 2011		597,418		$	12.41
Grants		29,000			13.59
Vestings		(114,097	)		11.39

Unvested stock awards outstanding at September 30, 2012		512,321			12.71

During the quarter and nine months ended September 30, 2012, the Company recognized in Salaries and benefits $469,000 and $1,406,000, respectively, related to amortization of the grant date fair value of employee performance- and service-based stock awards. The amounts amortized for these periods assumed that performance criteria, if applicable, would continue to be met for related initial measurement periods. In addition, the Company recognized in Other general and administrative expense $94,000 and $255,000 related to amortization of the grant date fair value of service-based director stock awards during the quarter and nine months ended September 30, 2012, respectively. All service-based stock awards, as well as performance-based stock awards granted in 2008 and 2009, are entitled to receive dividends on a current basis without risk of forfeiture if the related awards do not vest. Performance-based awards granted subsequent to 2009 defer the payment of dividends accruing during the vesting period until vesting and if the related awards do not vest these accrued dividends will be forfeited. At September 30, 2012 dividends accrued pertaining to these awards totaled $643,000 and are included in Common stock dividend payable. Unrecognized compensation expense for unvested stock awards totaled $3.5 million as of September 30, 2012, to be expensed over a weighted average period of 1.5 years, assuming performance criteria, if applicable, are met for related initial measurement periods.

Option awards currently outstanding have contractual terms and vesting requirements at the grant date of ten years and were issued with strike prices equal to the quoted market prices of the Company’s common shares on the date of grant. The fair value of each option award was estimated on the date of grant using a Black-Scholes option pricing model. The Company estimated option exercises, expected holding periods and forfeitures based on past experience and expectations for option performance and employee or director attrition. Risk-free rates were based on market rates for the expected life of the options. Expected dividends were based on historical experience and expectations for future performance. Expected volatility factors were based on historical experience. No option awards were granted during the nine months ended September 30, 2012. Option award activity for the nine months ended September 30, 2012 is summarized below:


	*Number of* *Shares*			*Weighted Average* *Exercise Price*
Option awards outstanding at December 31, 2011		256,250		$	10.71
Exercises		(158,750	)		10.14

Option awards outstanding at September 30, 2012		97,500			11.63

Exercisable option awards outstanding as of September 30, 2012 totaled 97,500 shares with a weighted average remaining contractual term of 5.0 years, an average exercise price of $11.63 and an aggregate intrinsic value of $190,000. The total intrinsic value of option awards exercised during the quarter and nine months ended September 30, 2012 was $495,000 and $620,000, 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 officers. In general the Company matches up to 50% of a participant’s voluntary contribution up to a maximum of 6% of a participant’s compensation and makes discretionary contributions of up to another 3% of compensation regardless of participation in the plans. Company contributions are subject to certain vesting requirements. During the quarter and nine months ended September 30, 2012, the Company recognized in Salaries and benefits $86,000 and $336,000 related to contributions to these plans, respectively.