CAPSTEAD MORTGAGE CORP - 10-Q Quarterly Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2002

OR

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: 1-8996

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

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 (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
---- ----

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date.

Common Stock ($0.01 par value) 13,909,336 as of November 11, 2002

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CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002

INDEX

PART I. -- FINANCIAL INFORMATION

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ITEM 1. FINANCIAL STATEMENTS

PART I. -- FINANCIAL INFORMATION
CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

See accompanying notes to consolidated financial statements.

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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

See accompanying notes to consolidated financial statements.

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CAPSTEAD MORTGAGE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

See accompanying notes to consolidated financial statements.

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CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
(UNAUDITED)

NOTE 1 -- BUSINESS

Capstead Mortgage Corporation 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
currently include, but are not limited to, adjustable-rate single-family
residential mortgage-backed 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 (see NOTE 7), intended to
produce attractive returns due largely to a higher risk of default and reduced
liquidity compared to Agency Securities. The Company continues to evaluate
suitable real estate-related investments, which may include more
credit-sensitive assets. Management believes that such investments, when
combined with the prudent use of leverage, can provide attractive returns over
the long term with less sensitivity to changes in interest rates.

Capstead's investment portfolios declined during 2001 and 2002 primarily because
of high levels of mortgage prepayments. To the extent proceeds of runoff or
asset sales are not reinvested, or cannot be reinvested, at a rate of return at
least equal to the rate previously earned on that capital, earnings may decline.
The future size and composition of Capstead's investment portfolios will depend
on market conditions, including levels of mortgage prepayments and the
availability on a timely basis of suitable investments at attractive pricing.

NOTE 2 -- BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
("GAAP") for interim financial information and with the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the quarter and nine months ended September 30,
2002 are not necessarily indicative of the results that may be expected for the
calendar year ending December 31, 2002. For further information refer to the
consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended December 31, 2001.

NOTE 3 -- THIRD QUARTER COMMON DIVIDEND

On October 17, 2002 the Board of Directors declared a third quarter dividend of
$1.32 per common share, payable November 20, 2002 to stockholders of record as
of November 7, 2002.

NOTE 4 -- 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

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share equivalents outstanding, giving effect to dilutive stock options and
dilutive convertible preferred shares. The components of the computation of
basic and diluted net income per share were as follows (in thousands, except per
share data):

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 during the periods
presented. The Series B preferred shares became dilutive after a new conversion
rate went into effect July 2, 2001 (0.3559 common shares for each Series B
preferred share converted), even though few actual Series B conversions
subsequently occurred because it was uneconomical to convert at the market
prices of both the common shares and Series B preferred shares in effect during
the ensuing periods.

NOTE 5 -- 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 backed primarily by
single-family non-conforming residential mortgage loans whereby the related
credit risk of the underlying loans is borne by AAA-rated private mortgage
insurers ("Non-agency Securities"). 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 at September 30, 2002
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. Commercial loans held by the Company as of
September 30, 2002 consist of a loan to a joint venture that holds commercial
real estate. 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 5 years. Medium-term investments either
(i) have fixed rates of interest and initial expected weighted average lives of
5 years or less, (ii) are secured by mortgage loans that have an initial
fixed-rate

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period of 3 or 5 years after origination and then adjust annually based on a
specified margin over the 1-year Constant Maturity U.S. Treasury Note Rate
("1-year CMT"), or (iii) are secured by mortgage loans that have initial
interest rates that adjust one time, approximately 3 or 5 years after
origination, based on a specified margin over Fannie Mae yields for 30-year,
fixed-rate commitments at the time of adjustment. Adjustable-rate investments
have interest rates that adjust at least annually to more current interest
rates. For instance, mortgage loans underlying adjustable-rate mortgage ("ARM")
securities either (i) adjust annually based on a specified margin over 1-year
CMT, (ii) adjust semiannually based on a specified margin over the 6-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").
Adjustable-rate investments also include investments previously classified as
medium-term that have begun adjusting annually based on a specified margin over
1-year CMT. CMBS and commercial loans held as of September 30, 2002 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 11).

(b) Average Coupon is presented as of the indicated balance sheet date.
Average Effective Rate is presented for the quarter then ended,
calculated including mortgage insurance costs on non-agency securities
and excluding unrealized gains and losses.

(c) As of the indicated dates, these portfolios consisted nearly
exclusively of adjustable-rate investments.

In connection with the formation of private mortgage pass-through securities
prior to 1995, the Company was required to establish reserve funds available to
pay special hazard (e.g. earthquake or mudslide-related losses) or certain
bankruptcy costs. The private mortgage pass-through securities were

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subsequently held as Non-Agency Securities, pledged as CMO collateral or sold to
third parties. Included in Prepaids, receivables and other assets are $4.7
million in special hazard reserve funds and $1.2 million of bankruptcy reserve
funds associated with $81 million and $85 million of loans outstanding as of
September 30, 2002, respectively.

NOTE 6 -- CMO COLLATERAL AND INVESTMENTS

CMO collateral consists of primarily fixed-rate mortgage securities
collateralized by single-family residential mortgage loans and related
short-term investments, both 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 short-term investments. All
collections on the pledged mortgage securities 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):

Pledged mortgage securities are primarily private mortgage pass-through
securities whereby the related credit risk of the underlying loans is borne by
AAA-rated private mortgage insurers or subordinated bonds within the related CMO
series to which the collateral is pledged. The Company has retained $135,000 of
credit risk held in the form of subordinated bonds associated with $101 million
of Pledged CMO Collateral outstanding as of September 30, 2002. CMO investments
currently consist of subordinated bonds retained by the Company in connection
with two 1993 mortgage loan sales that are available to pay special hazard or
certain bankruptcy costs associated with $59 million of loans outstanding as of
September 30, 2002. The weighted average effective interest rate for total
Pledged CMO Collateral was 6.73% during the quarter ended September 30, 2002.

NOTE 7 -- REAL ESTATE HELD FOR LEASE

On May 1, 2002 Capstead acquired six independent senior living facilities
wherein the operator of the facility provides the tenants little, if any,
medical care and one skilled nursing facility (collectively, the "Properties").
Subsequent to quarter-end, the skilled nursing facility was sold for cash
proceeds of approximately $4.1 million, net of selling costs. No gain or loss
will be recognized on this transaction. After adjustment for the sale of the
skilled nursing facility, the aggregate purchase price of the Properties was
$140.0 million including approximately $3.4 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 "Bonds").

The Properties were acquired pursuant to purchase agreements initially
negotiated and executed by subsidiaries of Brookdale Living Communities, Inc.
(collectively with its subsidiaries, "Brookdale") with an affiliate of Apartment
Investment Management Company ("AIMCO") and subsequently assigned to Capstead.
The Company has 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

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Fortress Investment Group, LLC (together with its affiliates, "Fortress").
Fortress is Capstead's largest stockholder and Wesley R. Edens, Capstead's
Chairman of the Board and Chief Executive Officer, also serves as Fortress'
chairman and chief executive.

The lease agreements negotiated with Brookdale consist 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 at the end of five years,
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 the operation of the Properties, including real
estate taxes, other governmental 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. After an initial three-month
rent concession period, the cash return on Capstead's equity is expected to
exceed 15% on an annualized basis and is subject to annual increases based upon
increases (capped at 3%) in the Consumer Price Index. The Lease qualifies as an
operating lease for financial reporting purposes with future minimum rentals
expected to exceed $10 million per year. The following table summarizes carrying
amounts of the Properties as of September 30, 2002 (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 Bonds held by a tax-exempt bond fund (the "TEB Fund Bonds") for a purchase
price of $60.7 million. With Capstead's May 1, 2002 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.
Brookdale posted a $17 million bank letter of credit for the benefit of the swap
counterparty to secure its obligations thereunder. The swap counterparty is a
financial institution affiliated with the tax-exempt bond fund. Upon termination
of the swap, Brookdale is obligated to pay the swap counterparty $65.4 million
and will receive an amount equal to the proceeds from either a sale or
refinancing of the TEB Fund Bonds, as the case may be.

The Lease contemplates Capstead causing the refinancing of the TEB Fund Bonds
through the issuance of new credit-enhanced adjustable-rate tax-exempt bonds to
unaffiliated investors. In addition, Capstead agreed to provide credit
enhancement on up to $12.0 million of the new bonds by arranging for a letter of
credit from a rated lending institution. Brookdale will compensate Capstead for
arranging the letter of credit by paying additional base rent. In connection
with its assumption of the TEB Fund Bonds, Capstead deposited $8.4 million in
mortgage securities with the bond trustee (which securities will be returned to
Capstead on the refinancing date). The Company currently expects to complete the
refinancing of all of the Bonds by year-end. This refinancing is expected to
enhance the value of the Properties by significantly lowering interest costs.

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NOTE 8 -- REPURCHASE ARRANGEMENTS AND SIMILAR BORROWINGS

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):

Borrowings made under uncommitted repurchase arrangements with investment
banking firms 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. Commercial bank borrowings
at September 30, 2002 consist of an adjustable-rate loan that matures in 2005
secured by a commercial loan investment. The terms and conditions of repurchase
arrangements and similar borrowings are negotiated on a
transaction-by-transaction basis. The weighted average effective interest rate
on repurchase arrangements and similar borrowings was 1.84% during the quarter
ended September 30, 2002.

NOTE 9 -- 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 or quarterly 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 will be 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, generally at the Company's option, 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 6.84% during the quarter ended September 30, 2002.

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NOTE 10 -- BORROWINGS SECURED BY REAL ESTATE

The components of borrowings secured by real estate and related weighted average
interest rates during the quarter ended September 30, 2002, 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 secured by
mortgages on five senior living facilities that mature in 2026. The Company
anticipates completing the refinancing of these bonds prior to year-end (see
NOTE 7).

NOTE 11 -- DISCLOSURES REGARDING FAIR VALUES OF DEBT SECURITIES

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 presented herein 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.

The fair value of Agency Securities, Non-agency Securities, CMBS and CMO
investments 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 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.
Commercial loans and other investments not held in the form of debt or equity
securities are excluded from these disclosures.

The following tables summarize fair value disclosures for available-for-sale
debt securities (in thousands):

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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 Securities and Non-agency Securities. Fair value disclosures
for debt securities held-to-maturity were as follows (in thousands):

Sales of released CMO collateral classified as held-to-maturity occasionally
occur provided the collateral has paid down to within 15% of its original
issuance amounts. Dispositions of debt securities were as follows (in
thousands):

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NOTE 12 -- COMPREHENSIVE INCOME

Comprehensive income is net income plus other comprehensive income (loss),
which, for the periods presented, consists primarily of the change in unrealized
gain on debt securities classified as available-for-sale. The 2001 periods also
include the effect on other comprehensive income (loss) of adopting Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). The following table provides information
regarding comprehensive income (in thousands):

NOTE 13 -- NET INTEREST INCOME ANALYSIS

The following tables summarize interest income and interest expense and weighted
average interest rates pertaining to the Company's investments in financial
assets (excludes investments in real estate and related borrowings) (dollars in
thousands):

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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 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.

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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 1999, these actions were consolidated
and in July 2000, the court appointed a lead plaintiff group. An amended
complaint was filed in October 2000. The amended complaint claims that as a
result of alleged improper actions, the market prices of the Company's equity
securities were artificially inflated during the period between April 17, 1997
and June 26, 1998. The amended complaint seeks monetary damages in an
undetermined amount. In February 2001, the Company responded to this amended
complaint with a motion to dismiss all allegations against the Company and the
named officers. In April 2001, the plaintiffs responded to the Company's motion
to dismiss and the Company filed its reply to the plaintiffs' response in May
2001. The Company believes it has meritorious defenses to the claims and intends
to vigorously defend the actions. Based on available information, management
believes the resolution of these suits will not have a material adverse effect
on the financial position of the Company.

NOTE 15 -- TRANSACTIONS WITH AFFILIATES

Fortress is Capstead's largest stockholder controlling over 26% of the Company's
outstanding common shares. Through a management contract, Fortress provides the
services of Mr. Edens as Capstead's chairman and chief executive and of other
individuals as necessary to perform support services for Mr. Edens. Under the
terms of this contract, Fortress is entitled to a $375,000 base annual fee and a
cash management incentive fee. Included in Other operating expense is $281,250
of base fees paid to Fortress for services rendered during the nine months ended
September 30, 2002 and 2001, respectively. Fortress' management incentive fee is
included in Management and affiliate incentive fee and is based on the Company's
expected performance against predetermined benchmarks established by members of
the Board of Directors independent of Fortress. See NOTE 7 for more information
on Fortress and Mr. Edens and Fortress' affiliation with Brookdale, which has
leased Capstead's recently acquired Properties.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FINANCIAL CONDITION

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 currently include, but are not limited to, adjustable-rate
single-family residential mortgage-backed 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, intended to produce attractive returns due largely to
a higher risk of default and reduced liquidity compared to Agency Securities. As
existing investments prepay or mature, Capstead has the opportunity to continue
to reinvest a portion of its equity capital into investments that can produce
attractive returns over the long term, with less sensitivity to changes in
interest rates than Agency Securities. To this end, the Company continues to
actively evaluate suitable real estate-related investments, which may include
more credit-sensitive assets. There can be no assurance that suitable
investments at attractive pricing will be available on a timely basis to replace
portfolio runoff as it occurs (see "Effects of Interest Rate Changes", "Risks
Associated with Credit-Sensitive Investments" and "Risks Associated with Owning
Real Estate").

MORTGAGE SECURITIES AND SIMILAR INVESTMENTS

As of September 30, 2002, mortgage securities and similar investments consisted
primarily of adjustable-rate mortgage ("ARM") Agency Securities (see "NOTE 5" to
the accompanying consolidated financial statements for discussion of how the
Company classifies its mortgage securities and similar investments). 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 ("Non-agency Securities"). In connection with the formation of
private mortgage pass-through securities prior to 1995, the Company was required
to establish reserve funds available to pay special hazard (e.g. earthquake or
mudslide-related losses) or certain bankruptcy costs. The private mortgage
pass-through securities were subsequently held as Non-agency Securities, CMO
collateral or sold to third parties. Included in Prepaids, receivables and other
assets are $4.7 million in special hazard reserve funds and $1.2 million of
bankruptcy reserve funds associated with $81 million and $85 million of loans
outstanding as of September 30, 2002, respectively. 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
September 30, 2002 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. Commercial loans held by
the Company at September 30, 2002 consist of a loan to a joint venture that
holds commercial real estate (see "Risks Associated With Credit-Sensitive
Investments").

Mortgage securities are financed under repurchase arrangements with investment
banking firms pursuant to which the portfolios are pledged as collateral.
Capstead financed its commercial loan investment with a loan from a commercial
bank. Should the Company acquire additional financial assets that are not
mortgage-backed securities, similar financing arrangements with other parties,
such as commercial banks, may be employed (see "Liquidity and Capital
Resources").

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The Company's portfolio of mortgage securities and similar investments declined
during the nine months ended September 30, 2002 to $2.7 billion from $3.5
billion at December 31, 2001, primarily as a result of portfolio runoff caused
by mortgage prepayments. Although still at elevated levels, mortgage prepayment
rates moderated during the first nine months of 2002 as interest rates on most
of the mortgage loans underlying the Company's ARM securities have reset to
levels at or below current interest rates on fixed-rate mortgage loans, reducing
or eliminating the advantage for these homeowners to refinance. Prepayments
should continue to moderate as the remaining loans reset to lower levels.
Acquisitions during 2002 have been limited to $74.8 million of CMBS and
commercial loans, $29.4 million of ARM securities released from "sold CMO"
indentures, and $140.0 million of senior living properties (see "CMO Collateral
and Investments" and "Real Estate Held for Lease"). 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 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
suitable investments at attractive pricing. (see "Effects of Interest Rate
Changes").

The following yield and cost analysis illustrates results achieved during the
third quarter 2002 for components of the mortgage securities and similar
investments portfolio and anticipated fourth quarter 2002 asset yields and
borrowing rates based on interest rates in effect on November 7, 2002 (dollars
in thousands):

(a) Basis represents the Company's investment before unrealized gains and
losses. Actual asset yields, runoff rates, borrowing rates and
resulting financing spread are presented on an annualized basis.

(b) Projected annualized yields for the fourth quarter of 2002 reflect ARM
coupon resets and lifetime prepayment assumptions as adjusted for
expected prepayments for this quarter only, as of November 7, 2002.
Actual yields realized in future periods will largely depend upon (i)
changes in portfolio composition, (ii) ARM coupon resets, (iii) actual
prepayments and (iv) any changes in lifetime prepayment assumptions.

(c) The Company generally 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").

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The overall yield earned on this portfolio averaged 5.04% during the third
quarter of 2002, a decline of 82 basis points from an average yield of 5.86%
earned during the fourth quarter of 2001. Yields on ARM securities fluctuate as
coupon interest rates on the 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 on November 7, 2002,
the average yield on the portfolio could decline approximately 109 basis points
by the third quarter of 2003. 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 (see "Effects of Interest Rate
Changes").

Average rates on the Company's borrowings secured by mortgage securities and
similar investments were 1.84% during the third quarter of 2002. Having
benefited from reductions in the Federal Funds Rate totaling 475 basis points
during 2001, short-term interest rates have been relatively stable during the
first three quarters of 2002. With the action taken by the Federal Reserve on
November 6, 2002 to reduce the Federal Funds Rate by an additional 50 basis
points, the Company's borrowing rates should decline by approximately 45 basis
points over the next two quarters, although this decline is not expected to
offset the effects on earnings of declining portfolio yields and balances. 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 (see
"Effects of Interest Rate Changes").

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 single-family residential mortgage loans. From time to
time, the Company may purchase mortgage loans from originators or conduits,
place these loans into private mortgage pass-through securities and issue CMOs
or other securities backed by these securities. The Company may or may not
retain a significant residual economic interest in these securitizations. Most
of the Company's securitizations have been 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").
Other securitizations issued by the Company in 1993 and prior were treated as
sales transactions (referred to as "sold CMOs"). During 2001 and 2002, the
Company has not issued any CMOs. From time to time, the Company exercises its
right to redeem previously issued CMOs (referred to as "clean-up calls") and
either sell or hold the released collateral for investment. Early in 2002, the
Company exercised clean-up calls related to two sold CMOs acquiring $29.4
million of ARM securities released from the related indentures.

Credit risk associated with pledged CMO collateral is borne by AAA-rated private
mortgage insurers or by subordinated bonds usually sold to investors. The
Company has retained $135,000 of credit risk held in the form of subordinated
bonds associated with $101 million of pledged CMO collateral outstanding as of
September 30, 2002. In addition, Capstead retained $2.8 million of subordinated
bonds in connection with two sold CMOs that are available to pay special hazard
costs or certain bankruptcy costs associated with $59 million of loans
outstanding as of September 30, 2002. Other than clean-up call rights, the
Company does not hold any other interests in sold CMOs.

CMO collateral and investments, net of related bonds, was $11.5 million at
September 30, 2002, down from $17.3 million at December 31, 2001. Included in
this net investment are $5.2 million of remaining CMO collateral premiums (net
of CMO bond premiums). Similar to premiums on other financial assets, CMO
collateral and bond premiums are amortized to income as CMO collateral yield or
bond expense adjustments based on both actual prepayments and lifetime
prepayment assumptions (see "Effects of Interest Rate Changes").

-19-

REAL ESTATE HELD FOR LEASE

On May 1, 2002 Capstead closed on its first direct investment in real estate, a
portfolio of seven senior living properties in five states (the "Properties").
Six of the seven Properties are primarily independent senior living facilities
wherein the operator of the facility provides the tenants little, if any,
medical care. The smallest property in the portfolio is primarily a skilled
nursing facility that was sold October 31, 2002. No gain or loss will be
recognized on this transaction. The acquisition of the Properties is in keeping
with the Company's strategy of making suitable real estate-related investments
intended to produce attractive returns over the long term, with less sensitivity
to changes in interest rates than most investments in residential
mortgage-backed securities. The following table summarizes the properties
acquired:

(a) IL refers to Independent Living units, AL refers to Assisted Living
units and SNF refers to Skilled Nursing Facility units.

(b) As of September 2002.

(c) Sold October 31, 2002 for net proceeds of approximately $4.1 million.

The aggregate purchase price of the Properties (after adjustment for the October
31, 2002 sale of the skilled nursing facility) was $140.0 million including the
assumption by Capstead of $19.7 million of related mortgage debt and $101.1
million of tax-exempt bond debt (the "Bonds"). The Properties were acquired from
an affiliate of Apartment Investment and Management Company ("AIMCO") pursuant
to a purchase contract negotiated by a subsidiary of Brookdale Living
Communities, Inc. (collectively with its subsidiaries, "Brookdale"), and
assigned to Capstead. Brookdale, an owner, operator, developer and manager of
senior living facilities, is a majority-owned affiliate of Fortress Investment
Group, LLC (together with its affiliates, "Fortress"). Fortress is Capstead's
largest stockholder and Wesley R. Edens (Fortress' Chairman of the Board and
Chief Executive Officer) serves as Capstead's chairman and chief executive.

The Company has entered into a long-term 'net-lease' arrangement with Brookdale
(the "Lease") under which Brookdale is responsible for the ongoing operation and
management of the Properties. The Lease has an initial term of 20 years and
provides for two 10-year renewal periods. Beginning at the end of five years,
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. After an initial three-month
rent concession period, the cash return on Capstead's equity is expected to
exceed 15% on an annualized basis and is subject to annual increases based upon
increases (capped at 3%) in the Consumer Price Index. 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 (see "Risks
Associated with Owning Real Estate").

-20-

The Lease contemplates Capstead causing the refinancing of $71.4 million of the
Bonds held by a tax-exempt bond fund (the "TEB Fund Bonds") through the issuance
of new credit-enhanced adjustable-rate tax-exempt bonds. In addition, Capstead
agreed to provide credit enhancement on up to $12.0 million of the new bonds by
arranging for a letter of credit from a rated lending institution. Brookdale
will compensate Capstead for arranging the letter of credit by paying additional
base rent. In connection with its assumption of the TEB Fund Bonds, Capstead
deposited $8.4 million in mortgage securities with the bond trustee (which
securities will be returned to Capstead on the refinancing date). The Company
currently expects to complete the refinancing of all of the Bonds by year-end.
This refinancing is expected to enhance the value of the Properties by
significantly lowering interest costs.

BOOK VALUE PER COMMON SHARE

At September 30, 2002 book value per common share was $14.34, compared to $14.59
at December 31, 2001, (calculated excluding the $1.32 third quarter 2002 common
dividend declared October 18, 2002, and assuming redemption of the Series A and
B preferred shares). The decline in book value since year end primarily reflects
the impact of the decline in size of the Company's investment portfolios that
consist primarily of mortgage-backed securities classified as held
available-for-sale and marked-to-market through stockholders' equity. The market
value of these investments can be expected to continue to decline with runoff
and to fluctuate with changes in interest rates and market liquidity, and such
changes will be reflected in book value per common share. Book value will also
be affected by other factors, including the level of dividend distributions and
depreciation charges on net-leased real estate; however, temporary changes in
market values of investments not held in the form of debt or equity securities
generally will not affect book value.

UTILIZATION OF CAPITAL AND POTENTIAL LIQUIDITY

The Company's utilization of capital and potential liquidity as of September 30,
2002 were as follows (in thousands):

(a) Based on maximum borrowings available under existing uncommitted
repurchase arrangements considering the fair value of related
collateral as of September 30, 2002 (see "Liquidity and Capital
Resources"). Also includes proceeds from the October 31, 2002 sale of
the Windsong skilled nursing facility.

(b) Represents cash and cash equivalents.

(c) The third quarter common dividend was declared October 18, 2002 and is
payable November 20, 2002 to stockholders of record as of November 7,
2002.

-21-

The Company generally finances its mortgage securities and similar investments
with investment banking firms with repurchase arrangements and similar
borrowings (see "Liquidity and Capital Resources"). 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" and "Effects of Interest Rate
Changes").

RESULTS OF OPERATIONS

Comparative net operating results (interest income or lease revenue, net of
related interest expense and, in the case of 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 calculated after
excluding depreciation on real estate, gain on asset sales and the
dilutive effects of the Series B preferred shares. As such, operating
income represents a measure of the amount of funds generated by
operations, which may, at the discretion of Capstead's Board of
Directors, be used for reinvestment or distributed to common
stockholders as dividends. 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.
Operating income per 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.

-22-

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. During 2001 and
thus far in 2002, the Company has not added significantly to these portfolios
while runoff has been relatively high resulting in declining financial asset
portfolio balances. Financial assets that have been acquired during this time
period have primarily consisted of adjustable-rate CMBS and other commercial
loans, the earnings from which are less sensitive to changes in interest rates.
In addition, 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. See "Financial Condition - Mortgage Securities and Similar Investments"
and "Real Estate Held For Lease" for further discussion of the current operating
environment and the Company's goals regarding redeploying capital made available
by portfolio runoff.

Net margins on financial assets and related financing spreads (the difference
between yields earned on investments and the rates charged on related
borrowings) continue to benefit from actions taken by the Federal Reserve during
2001 to aggressively 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. Net margins and spreads are expected to
continue declining as yields on the Company's ARM securities continue resetting
lower and portfolio balances continue declining because of scheduled principal
payments, maturities and relatively high mortgage prepayments (see "Effects of
Interest Rate Changes").

Agency Securities remained the primary contributor to operating results during
the quarter and nine months ended September 30, 2002; however, the impact of
lower yields and a significantly lower average outstanding portfolio was evident
in the current quarter results, which were less than the same period in 2001
despite lower borrowing rates. Year-to-date results still outpaced the prior
year. Yields for this portfolio averaged 4.99% and 5.32% during the quarter and
nine months ended September 30, 2002, compared to 6.22% and 6.66% during the
same periods in 2001, while borrowing rates averaged 1.79% and 1.80% during the
quarter and nine months ended September 30, 2002 compared to 3.63% and 4.69%
during the same periods in 2001. The average outstanding Agency Securities
portfolio was $2.5 billion and $2.7 billion during the quarter and nine months
ended September 30, 2002 compared to $3.8 billion and $4.3 billion during the
same periods in 2001.

Non-agency Securities contributed more to operating results during the current
quarter while contributing less during the nine months ended September 30, 2002
than in the same periods in 2001 primarily because of differences between
periods in how much of the Company's liquidity was invested in this portfolio.
During 2002 the Company has consistently invested approximately $40 million of
its liquidity in this portfolio. This contrasts with the quarter ended September
20, 2001 when only $9 million of liquidity was invested in this portfolio and
the first six months of 2001 when the portfolio was funded almost entirely with
equity. Yields for this portfolio (calculated including mortgage insurance
costs) were lower averaging 5.25% and 5.71% during the quarter and nine months
ended September 30, 2002, compared to 7.18% and 7.82% during the same periods in
2001, while borrowing rates averaged 1.87% and 1.92% in 2002 compared to 3.67%
and 3.81% in 2001. The average outstanding portfolio was $83 million and $88
million during the quarter and nine months ended September 30, 2002 compared to
$77 million and $90 million during the same periods in 2001. Borrowings averaged
$43 million and $48 million in 2002 compared to $68 million and $26 million in
2001.

CMBS and other commercial loans contributed more to operating results during the
quarter and nine months ended September 30, 2002 than in the same periods in
2001 primarily because of over

-23-

$175 million in portfolio additions since the fourth quarter of 2001. Third
quarter results include $388,000 earned on a $15 million participation in a
secured loan acquired early in the quarter and subsequently sold (see below).
The average outstanding portfolio was $199 million during both the quarter and
nine months ended September 30, 2002 compared to $72 million during the same
periods in 2001. Borrowings averaged $166 million and $170 million during the
quarter and nine months ended September 30, 2002 compared to $60 million and $61
million during the same periods in 2001. The portfolio yielded 5.56% and 5.01%
during the quarter and nine months ended September 30, 2002 while borrowing
rates averaged 2.50% and 2.48% producing financing spreads of 3.06% and 2.53%.
This compares with yields of 6.19% and 7.22% and borrowing rates of 4.24% and
5.22% for spreads of 1.95% and 2.00% during the same periods in 2001. Because
this portfolio currently consists of adjustable-rate assets secured by
borrowings with similar interest rate adjustment features, future changes in
short-term interest rates should have little effect on financing spreads.

CMO collateral and investments contributed less to operating results primarily
because of higher prepayments on the underlying pledged CMO collateral. 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 provide
a positive return on capital employed in future periods (see "Financial
Condition - CMO Collateral and Investments").

Real estate held for lease results reflect ownership of these properties since
May 1, 2002 (see "Financial Condition - Real Estate Held For Lease"). 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 the current quarter reflects the sale of a recently
acquired $15 million participation in a one-year secured loan for a gain of $1.9
million. This gain effectively accelerated into the current quarter much of what
would have been earned on this particular investment over the next year had it
been held to maturity.

CMO administration revenue continues to trend lower primarily because a
declining portfolio of CMOs for which the Company provides administrative
services. As these CMOs pay down, related fee income is expected to decline.
Other revenue benefited from better than anticipated settlements of liabilities
related to the Company's 1998 sale of its servicing operation.

Management and affiliate incentive fee accruals reflect current year
expectations for the amount the Company's performance will exceed predetermined
benchmarks established by members of the Board of Directors that are independent
of Fortress.

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, payments received on real estate held
for lease, and excess cash flows on CMO collateral and investments. The Company
generally uses its liquidity to pay down borrowings to reduce borrowing costs.
The table included under "Financial Condition - Utilization of Capital and
Potential Liquidity" illustrates additional funds potentially available to the
Company as of September 30, 2002. 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.

-24-

Borrowings under repurchase arrangements secured by Agency Securities and
Non-agency Securities generally have maturities of less than 31 days. These
borrowings totaled approximately $2.2 billion at September 30, 2002. 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")
rates 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 rates, credit quality and
liquidity conditions within the investment banking, mortgage finance and real
estate industries (see "Effects of Interest Rate Changes").

Borrowings under repurchase arrangements with investment banking firms secured
by CMBS and from commercial banks secured by investments in commercial loans
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 approximately $161 million at September 30, 2002.
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 (see "Effects of
Interest Rate Changes" and "Risks Associated With Credit-Sensitive
Investments").

CMO borrowings totaled approximately $1.4 billion at September 30, 2002 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. The maturity of each CMO series is affected by
mortgage prepayments and clean-up calls.

With its acquisition of senior living properties during the second quarter of
2002, Capstead assumed approximately $20 million in mortgage financing from a
commercial bank that matures in 2009 and $101 million in tax-exempt bond debt
that matures in 2026. The tax-exempt bonds are expected to be refinanced prior
to year-end (see "Financial Condition - Real Estate Held For Lease").

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, if any, 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. 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.

-25-

As of September 30, 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 guarantee 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 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 periodically based on
underlying indices (generally 1-year CMT rates). Since only a portion of the ARM
loans underlying these securities reset each month, and the terms of an ARM loan
generally limit the amount of such increases during any single interest rate
adjustment period and over the life of the loan, 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 could 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 September 30, 2002, the Company
did not own any Derivatives as a hedge against rising short-term interest rates.

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

-26-

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.

A change in interest rates also impacts earnings recognized from CMO collateral
and investments, which currently consist primarily of fixed-rate CMO residuals.
During periods of relatively low mortgage interest rates, prepayments on the
underlying mortgage loans generally will be higher, accelerating the
amortization of collateral and bond premiums. Conversely, if mortgage interest
rates rise significantly above interest rates on the collateral, principal
prepayments will typically diminish, improving the overall return on an
investment in a fixed-rate CMO residual because of an increase in time over
which the Company receives positive net cash flows and can amortize remaining
collateral and bond premiums.

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, 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.

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
effect 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

-27-

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 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:

o The risk that changes in economic conditions or real estate markets may
adversely affect the value of the properties.

o 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.

o 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.

o Changes in tax, zoning or other laws could make properties less
attractive or less profitable.

o 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.

-28-

o 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.

o 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.

o 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, and damage awards to private parties and additional
capital expenditures to remedy noncompliance. Existing requirements may
change and compliance with 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.

o 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.

-29-

o 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.

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:

o 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,
and for its CMO borrowings, estimates and judgments related to future
levels of mortgage prepayments are critical to this determination (see
"Effects of Interest Rate Changes").

o 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 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 11" to the accompanying consolidated financial statements for
discussion of how Capstead values its financial assets, "Risks of
Interest Rate Changes" and "Risks Associated with Credit-Sensitive
Investments").

o 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

-30-

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 (see "Risks Associated with
Owning Real Estate").

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.

-31-

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS

The information required by this Item is incorporated by reference to the
information included in Item 2. "Management's Discussion and Analysis of
Financial Condition and Results of Operations."

ITEM 4. CONTROLS AND PROCEDURES

As of September 30, 2002, an evaluation was performed under the supervision and
with the participation of the Company's management, including the Chief
Executive Officer ("CEO") and Executive Vice President - Finance ("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 September 30, 2002. There have been no significant changes
in the Company's internal controls or in other factors that could significantly
affect internal controls subsequent to September 30, 2002.

PART II. -- OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits: The following Exhibit is presented herewith:

Exhibit 12 - Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends.

Exhibit 99.1 - Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K: None

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

CAPSTEAD MORTGAGE CORPORATION

Date: November 11, 2002 By: /s/ WESLEY R. EDENS
------------------------------------
Wesley R. Edens
Chairman and Chief Executive Officer

Date: November 11, 2002 By: /s/ ANDREW F. JACOBS
-------------------------------------
Andrew F. Jacobs
Executive Vice President - Finance

-32-

CERTIFICATIONS

I, Wesley R. Edens, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Capstead Mortgage
Corporation;

2. Based on my knowledge, this quarterly 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 quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures 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 quarterly
report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

Date: November 11, 2002 By: /s/ WESLEY R. EDENS
------------------------------------
Wesley R. Edens
Chairman and Chief Executive Officer

-33-

CERTIFICATIONS

I, Andrew F. Jacobs, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Capstead Mortgage
Corporation;

2. Based on my knowledge, this quarterly 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 quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures 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 quarterly
report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

Date: November 11, 2002 By: /s/ ANDREW F. JACOBS
---------------------------------------
Andrew F. Jacobs
Executive Vice President - Finance

-34-

EXHIBIT INDEX