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: MARCH 31, 2003

OR

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

FOR THE TRANSITION PERIOD FROM TO
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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
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Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). 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) 14,007,752 as of April 30, 2003

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CAPSTEAD MORTGAGE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2003

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.

-3-

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.

-5-

CAPSTEAD MORTGAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(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, single-family residential
adjustable-rate mortgage ("ARM") 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, 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 the last several years primarily
because of high levels of mortgage prepayments and a lack of suitable investment
opportunities at attractive prices. Consequently, in 2001 and again in January
2003 (with the payment of the fourth quarter 2002 common dividend), Capstead
returned a significant portion of its equity capital to its common stockholders.
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 and common dividends may continue trending lower. 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

INTERIM FINANCIAL REPORTING

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 ended March 31, 2003 are not
necessarily indicative of the results that may be expected for the calendar year
ending December 31, 2003. 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, 2002.

STOCK-BASED COMPENSATION

The Company accounts for stock-based awards for employees and directors under
the recognition and measurement principles of APB No. 25, "Accounting for Stock
Issued to Employees," and related Interpretations ("APB25"). Under APB25,
compensation cost for stock-based awards for employees and directors is measured
as the excess, if any, of the quoted market price of the Company's stock at the
date of the grant over the amount to be paid to acquire the stock and is
recognized in Other operating expense as the awards vest and restrictions lapse.
The increase in total stock-based compensation expense if determined under the
fair value-based methodology prescribed under Statement of Financial Accounting

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Standards No. 123 "Accounting for Stock-based Compensation" ("SFAS 123") would
have been less than $25,000 for the three months ended March 31, 2003 and 2002,
respectively, which would have had no effect on reported net income per common
share for the periods presented.

NOTE 3 -- 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 share equivalents outstanding, giving effect to dilutive stock
options and dilutive convertible preferred shares. 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 components of the computation of basic and diluted net income per share were
as follows (in thousands, except per share data):

NOTE 4 -- 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 residential mortgage loans whereby the related credit risk of the
underlying loans is generally 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 as of March 31, 2003 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 March 31, 2003
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.

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Fixed-rate investments have fixed rates of interest and initial expected
weighted average lives of greater than five years. Adjustable-rate investments
have interest rates that adjust at least annually to more current interest
rates. For instance, mortgage loans underlying ARM securities either (i) adjust
annually based on a specified margin over the one-year Constant Maturity U.S.
Treasury Note Rate ("One-year CMT"), (ii) adjust semiannually based on a
specified margin over the six-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"). In addition, the terms of most ARM loans limit the amount of such
adjustments during any single interest rate adjustment period and over the life
of the loan. CMBS and commercial loans held as of March 31, 2003 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 10).

(b) Average Coupon Rate is presented as of the indicated balance sheet date.
Average Yield is presented for the quarter then ended, calculated
including amortization of premiums (discounts), 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 subsequently
held as Non-agency Securities, pledged as CMO collateral or sold to third
parties. As of

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March 31, 2003, included in Receivables and other assets as restricted cash are
$4.9 million in special hazard reserve funds and $1.2 million of bankruptcy
reserve funds associated with $64 million and $68 million of loans outstanding,
respectively.

NOTE 5 -- 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. With recent redemptions of
previously-issued CMO series, the Company no longer has credit risk held in the
form of subordinate bonds associated with Pledged CMO Collateral. The weighted
average yield for Pledged CMO Collateral and investments was 6.46% during the
quarter ended March 31, 2003.

NOTE 6 -- 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) (the "Properties"). Concurrent with the acquisition, the Company
entered into a long-term "net-lease" arrangement with Brookdale Living
Communities, Inc. (collectively with its subsidiaries, "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 Fortress Investment Group,
LLC (together with its affiliates, "Fortress"). Fortress is Capstead's largest
stockholder.

The net-lease arrangement consists 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. Because under the terms of the Lease, Brookdale is
responsible for changes in related debt service requirements, earnings

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from the Company's investment in net-leased real estate are generally not
affected by changes in interest rates. Included in Receivables and other assets
at March 31, 2003 are $3.2 million in unamortized rent abatements and $1.5
million of other rent receivables from Brookdale.

The components of real estate held for lease were as follows (in thousands):

NOTE 7 -- 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 March 31, 2003 consist of an adjustable-rate loan that matures in January
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 1.34% during the quarter
ended March 31, 2003.

NOTE 8 -- 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 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 is made
on any class of bonds until all classes having an earlier stated maturity have
been paid in full. 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 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
6.63% during the quarter ended March 31, 2003.

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The components of CMOs along with selected other information were as follows
(dollars in thousands):

NOTE 9 -- BORROWINGS SECURED BY REAL ESTATE

The components of borrowings secured by real estate and related weighted average
interest rates (calculated including bond issue cost amortization) for the dates
indicated 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 credit-enhanced
by Fannie Mae and secured by mortgages on the remaining five senior living
facilities. Interest rates on the bonds adjust weekly based on the Bond Market
Association Municipal Swap Index ("BMA Index"). Interest rate cap agreements
with notional amounts aggregating $100.8 million, five-year terms and cap rates
equal to a 6% BMA Index are held to provide funds to pay interest on the bonds
in excess of a 6% BMA Index, should that occur. The interest rate cap agreements
were valued at $543,000 at March 31, 2003 and included in Receivables and other
assets. Monthly principal and interest rate cap reserve fund payments are made
to the trustee for the eventual retirement of the bonds by 2032 and the purchase
of new cap agreements in 2007.

In connection with the issuance of the bonds in November 2002, Capstead placed
into escrow with the trustee reserves for repairs and replacements totaling $2.7
million. These funds are expected to be released by the trustee during 2003.
Another $6.0 million is held by the trustee in connection with Capstead posting
a $6.0 million letter of credit from a rated financial institution to
collateralize certain of the bonds. These funds, along with $411,000 of
principal and interest rate cap reserve funds, are included in Receivables and
other assets as restricted cash. Also included in Receivables and other assets
are $3.4 million in bond issue costs.

The weighted average effective interest rate for all borrowings secured by real
estate (calculated including bond issue cost amortization) was 3.65% for the
quarter ended March 31, 2003.

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NOTE 10 -- 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 and CMBS 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):

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.

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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):

NOTE 11 -- COMPREHENSIVE INCOME

Comprehensive income is net income plus other comprehensive loss, which, for the
periods presented, consists primarily of the change in unrealized gain on debt
securities classified as available-for-sale. The following table provides
information regarding comprehensive income (in thousands):

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NOTE 12 -- 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):

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.

NOTE 13 -- COMMITMENTS AND CONTINGENCIES

During 1998, twenty-four purported class action lawsuits were filed against the
Company 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 and the named officers
responded to this amended complaint with motions to dismiss all allegations made
by the plaintiffs. In April 2001 the plaintiffs responded to the motions to
dismiss and in May 2001 the Company and the named officers filed their reply to
the plaintiffs' response.

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By order dated March 31, 2003, the court granted the Company and the named
officers' motions to dismiss and entered an order dismissing the amended
complaint and denying the plaintiffs' request to further amend their complaint.
The plaintiffs have not yet indicated whether they intend to appeal the
dismissal of the amended complaint. Management continues to believe the final
resolution of this suit will not have a material adverse effect on the financial
position of the Company.

NOTE 14 -- TRANSACTIONS WITH AFFILIATES

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. This contract renews annually on
December 31 unless terminated by Fortress or by majority vote of the Board of
Directors that are independent of Fortress. Under the terms of the contract,
Fortress is entitled to a $375,000 base annual fee and a cash management
incentive fee. In addition, Fortress may be awarded long-term non-cash incentive
compensation, which may be in the form of stock options or grants. Included in
Other operating expense is $93,750 of base fees paid to Fortress for services
rendered during the three months ended March 31, 2003 and 2002, 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. No long-term non-cash compensation has been awarded.
See NOTE 6 for information regarding Fortress' involvement through its affiliate
Brookdale in the acquisition and long-term leasing of senior living facilities
acquired by Capstead in 2002.

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

FINANCIAL CONDITION

OVERVIEW

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, single-family
residential adjustable-rate mortgage ("ARM") 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
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
evaluate suitable real estate-related investments, which may include more
credit-sensitive assets. However, during the last several years the Company has
returned a significant portion of its equity capital to its common stockholders,
primarily because of a lack of suitable investment opportunities. 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 and, as a result,
earnings and dividends may continue trending lower (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 March 31, 2003, mortgage securities and similar investments consisted
primarily of ARM Agency Securities (see "NOTE 4" 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 generally 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 Receivables and other assets as
restricted cash are $4.9 million in special hazard reserve funds and $1.2
million of bankruptcy reserve funds associated with $64 million and $68 million
of loans outstanding as of March 31, 2003, 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 March 31, 2003 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 March 31, 2003 consist of a loan to a joint venture that holds
commercial real estate (see "Risks Associated With Credit-Sensitive
Investments").

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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").

The Company's portfolio of mortgage securities and similar investments declined
during the first quarter of 2003 to $2.2 billion from $2.4 billion at December
31, 2002, primarily as a result of portfolio runoff caused by mortgage
prepayments. Acquisitions during the quarter were limited to $65 million of
mortgage securities released from CMO indentures, $33 million of which were sold
(see "CMO Collateral and Investments"). 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 and dividends may continue trending lower. 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
first quarter of 2003 for components of the mortgage securities and similar
investments portfolio and anticipated second quarter 2003 asset yields and
borrowing rates based on interest rates in effect on April 24, 2003 (the date
first quarter 2003 results were released) (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 first quarter of 2003 reflect ARM
coupon resets and lifetime prepayment assumptions as adjusted for
expected prepayments for this quarter only, as of April 24, 2003.
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").

-17-

The overall yield earned on the portfolio averaged 4.35% during the first
quarter of 2003, a decline of 30 basis points from an average yield of 4.65%
earned during the previous quarter. 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 current rates, the average yield on
the portfolio could decline approximately 77 basis points by the first quarter
of 2004. 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 related borrowings were 1.34% during the first quarter of 2003.
The November 2002 action taken by the Federal Reserve to reduce the Federal
Funds Rate by 50 basis points, together with market expectations that the
Federal Funds Rate could be reduced further, led to a 28 basis point decline in
the Company's average borrowing rates during the first quarter. Further declines
in borrowing rates, if any, are not expected to fully 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"). Since 2000, 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. During the first quarter of 2003, the
Company exercised clean-up calls related to two financed CMOs and one sold CMO.

Credit risk associated with pledged CMO collateral is borne by AAA-rated private
mortgage insurers or by subordinated bonds usually sold to investors. With
recent redemptions of previously-issued CMOs, the Company no longer has credit
risk held in the form of subordinated bonds associated with outstanding pledged
CMO collateral. Other than clean-up call rights, the Company does not hold any
interests in sold CMOs.

CMO collateral and investments, net of related bonds, was $3.2 million at March
31, 2003, down from $8.6 million at December 31, 2002. Included in this net
investment are $1.3 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").

-18-

REAL ESTATE HELD FOR LEASE

In 2002 Capstead acquired six "independent" senior living properties (wherein
the operator of the facility provides the tenants little, if any, medical care)
(the "Properties"). The following table summarizes information about the
Properties:

(a) IL refers to Independent Living units, AL refers to Assisted Living units.
(b) As of March 31, 2003.

Concurrent with the acquisition of the Properties, the Company entered into a
long-term "net-lease" arrangement (the "Lease") with Brookdale Living
Communities, Inc. (collectively with its subsidiaries, "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 Fortress Investment Group,
LLC (together with its affiliates, "Fortress"). Fortress is Capstead's largest
stockholder.

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. 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").

BOOK VALUE PER COMMON SHARE

As of March 31, 2003, the Company's book value per common share was $8.10, a
decline of $0.13 from December 31, 2002 (calculated using the stated liquidation
preferences for Series A and B preferred shares). Book value declined primarily
because of dividend payments in excess of quarterly net income (approximately
$0.05 per share) and a reduction in the aggregate unrealized gain on the
Company's investments (most of which are debt securities carried at fair value
with changes in fair value reflected in stockholders' equity) as a result of
runoff caused by mortgage prepayments. This unrealized gain can be expected to
continue to decline with runoff and to fluctuate with changes in interest rates
and market liquidity, and such changes will largely 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 fair values of investments not held in the
form of debt or equity securities generally will not affect book value.

-19-

UTILIZATION OF CAPITAL AND POTENTIAL LIQUIDITY

The following table illustrates Capstead's utilization of capital and potential
liquidity as of March 31, 2003 in comparison with December 31, 2002 (in
thousands):

(a) Based on maximum borrowings available under existing uncommitted
repurchase arrangements considering the fair value of related
collateral as of March 31, 2003 (see "Liquidity and Capital
Resources").

(b) Represents cash and cash equivalents.

(c) The first quarter common dividend was declared March 13, 2003 and paid
April 21, 2003 to stockholders of record as of March 31, 2003.

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 repurchase and similar 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").

-20-

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 CMO redemptions, 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
and the amount and timing of any such gains are dependent upon
market conditions. 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 (see "Comparison of Operating Income and
Diluted Income per Share").

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 the last
several years, the Company has not added significantly to these portfolios while
runoff has been relatively high resulting in declining financial asset portfolio
balances. Given a lack of suitable investment opportunities at attractive
prices, the Company instead returned a significant amount of its equity capital
to its common stockholders in 2001 and again in January 2003 (with the payment
of its fourth quarter 2002 common dividend). 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

-21-

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) have declined steadily since peaking in early 2002 after having
benefited 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, more
significantly, declining portfolio balances primarily caused by relatively high
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 mortgage prepayments (see "Effects of Interest Rate Changes").

Agency Securities remained the primary contributor to operating results during
the quarter ended March 31, 2003; however, the impact of lower yields and a
significantly lower average outstanding portfolio was evident in the current
quarter results, which were less than in the same period in 2002 despite lower
borrowing rates. Yields for this portfolio averaged 4.30% during the current
quarter, compared to 5.60% during the same period in 2002, while borrowing rates
averaged 1.30% compared to 1.81% in 2002. The average outstanding Agency
Securities portfolio was $2.1 billion during the current quarter compared to
$3.0 billion during the same period in 2002.

Non-agency Securities contributed less to operating results during the quarter
ended March 31, 2003 compared to the same period in 2002 primarily because
declines in yields offset declines in borrowing rates and the benefits of
additional securities made available from the redemption of CMOs. Yields for
this portfolio (calculated including mortgage insurance costs) were lower
averaging 4.81% during current quarter compared to 6.16% during the same period
in 2002, while borrowing rates averaged 1.41% compared to 1.97% in 2002. The
average outstanding portfolio was $99 million during the current quarter
compared to $89 million during the same period in 2002.

CMBS and other commercial loans contributed less to operating results during the
quarter ended March 31, 2003 than in the same period in 2002 primarily because
of a lower average outstanding portfolio with the payoff during the current
quarter of several positions held by the Company throughout all of last year.
The average outstanding portfolio was $142 million during the current quarter
compared to $198 million during the same period in 2002. The portfolio yielded
4.68% during the current quarter while borrowing rates averaged 2.09% producing
financing spreads of 2.59%. This compares with yields of 4.44% and borrowing
rates of 2.40% for a spread of 2.04% during the same period in 2002. 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.

The CMO collateral and investments portfolio has declined significantly the last
several years primarily because of high prepayments on the underlying pledged
CMO collateral and the exercise of clean-up calls in which the Company retires
the related bonds and either sells the released CMO collateral for gains or
holds it as Non-agency Securities. 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 contribute significantly to operating results
in future periods (see "Financial Condition - CMO Collateral and Investments").

-22-

Real estate held for lease was acquired subsequent to the end of the first
quarter of 2002 (see "Financial Condition - Real Estate Held For Lease").

Gain on asset sales and CMO redemptions in the current quarter reflect the sale
of $33 million of fixed-rate released CMO collateral and a gain on the
redemption of CMO bonds related to $32 million in adjustable-rate collateral now
held as Non-agency Securities. Although additional gains from the redemption of
previously-issued securitizations could occur in the coming quarters, the amount
and timing of any such gains are dependent upon future market conditions.

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 was lower due to lower balances in overnight investments during
the current quarter.

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. Lower current year accruals reflect the recent trend of lower
earnings and dividends (see "Financial Condition - Overview").

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 March 31, 2003. 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.

Borrowings under repurchase arrangements secured by Agency Securities and
Non-agency Securities generally have maturities of less than 31 days. These
borrowings totaled approximately $2.0 billion at March 31, 2003. 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 $112 million at March 31, 2003. Should
Capstead make significant additional investments in credit-

-23-

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 $776 million at March 31,
2003 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 in 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. In November 2002, the
tax-exempt bonds were refunded with proceeds from issuing new 30-year
adjustable-rate tax-exempt bonds (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 derivative
financial instruments ("Derivatives") held 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. Because under
the terms of the Lease, Brookdale is responsible for changes in related debt
service requirements, earnings from the Company's investment in net-leased real
estate are generally not affected by changes in interest rates. 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. As of March 31, 2003, 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.

-24-

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 one-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 March 31,
2003, the Company did not own any Derivatives for this purpose.

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 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.

-25-

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 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.

-26-

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.

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

-27-

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.

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.

-28-

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 10" 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 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.

-29-

COMPARISON OF OPERATING INCOME AND DILUTED INCOME PER SHARE

The following table compares the calculation of operating income and operating
income per common share to net income and diluted net income per share (in
thousands, except per share amounts):

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 March 31, 2003, 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 March 31, 2003. There have been no significant changes in
the Company's internal controls or in other factors that could significantly
affect internal controls subsequent to March 31, 2003.

-30-

PART II. -- OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See NOTE 14 to the accompanying unaudited interim financial statements.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

(a) The annual meeting of stockholders was held April 24, 2003.

(b) The board members included in (c) below were elected to Capstead's Board of
Directors (constituting the entire Board of Directors).

(c) The following items were voted on at the annual meeting:

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits: The following Exhibits are 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:

Current Report on Form 8-K dated February 6, 2003 announcing fourth
quarter 2002 financial results, record date for Annual Meeting of
Stockholders and common dividend schedule for 2003.

Current Report on Form 8-K dated April 1, 2003 announcing ruling received
granting Capstead's motion to dismiss shareholder suit.

Current Report on Form 8-K dated April 24, 2003 announcing first quarter
2003 financial results.

-31-

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: May 6, 2003 By: /s/ WESLEY R. EDENS
------------------------------------
Wesley R. Edens
Chairman and Chief Executive Officer

Date: May 6, 2003 By: /s/ ANDREW F. JACOBS
------------------------------------
Andrew F. Jacobs
Executive Vice President - Finance

-32-

CAPSTEAD MORTGAGE CORPORATION
CERTIFICATION
PURSUANT TO SECTION 302(a) OF THE
SARBANES-OXLEY ACT OF 2002

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: May 6, 2003 By: /s/ WESLEY R. EDENS
-------------------------------------
Wesley R. Edens
Chairman and Chief Executive Officer

-33-

CAPSTEAD MORTGAGE CORPORATION
CERTIFICATION
PURSUANT TO SECTION 302(a) OF THE
SARBANES-OXLEY ACT OF 2002

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: May 6, 2003 By: /s/ ANDREW F. JACOBS
------------------------------------
Andrew F. Jacobs
Executive Vice President - Finance

-34-

INDEX TO EXHIBITS