Financing spreads (the difference between yields on the Company's interest-earning assets and rates on interest-bearing liabilities) averaged 164 basis points during the third quarter of 2008, down from 193 basis points earned during the second quarter of 2008. This decline of 29 basis points was primarily attributable to lower yields on acquisitions and lower coupon interest rates on mortgage loans underlying ARM securities that reset in recent periods and was exacerbated by the recent deterioration in credit market conditions, which began to increase borrowing rates on the Company's short-term borrowings late in the third quarter.
The size and composition of Capstead's investment portfolios depend on investment strategies being implemented by management, the availability of investment capital and overall market conditions, including the availability of attractively priced investments and suitable financing to appropriately leverage the Company's investment capital. Market conditions are influenced by, among other things, current levels of and expectations for future levels of short-term interest rates, mortgage prepayments and market liquidity. Risk Factors and Critical Accounting Policies Under the captions "Risk Factors" and "Critical Accounting Policies" are discussions of risk factors and critical accounting policies affecting Capstead's financial condition and results of operations that are an integral part of this discussion and analysis. Readers are strongly urged to consider the potential impact of these factors and accounting policies on the Company and its financial results.
Recent Common Equity Offerings
In February 2008 Capstead completed its third public offering since September 2007 raising nearly $127 million in new common equity capital, after underwriting discounts and offering expenses, through the issuance of 8.6 million common shares at a price of $15.50 per share and during the nine months ended September 30, 2008. In addition, the Company raised $107 million, after expenses, under its continuous offering program by issuing 8.6 million common shares at an average price of $12.39 per share, including proceeds of over $25 million, after expenses, during the third quarter through the issuance of 2.2 million common shares at an average price of $11.72. Year-to-date, these issuances increased common equity capital by nearly $234 million and were accretive to year-end book value by $1.27 per common share. Subsequent to quarter-end, the Company further increased its common equity capital by nearly $6 million, after expenses, through the issuance of 555,000 common shares at an average sales price of $10.08 per share under the continuous offering program. The Company may raise more capital in future periods, subject to market conditions and blackout periods associated with the dissemination of earnings and dividend announcements and other important company-specific news. The accompanying September 30, 2008 financial statements and related disclosures do not reflect the effects of shares issued subsequent to quarter-end. Book Value per Common Share
As of September 30, 2008, Capstead's book value per common share (calculated assuming liquidation preferences for the Series A and B preferred shares) was $10.02, a decrease of $0.40 from June 30, 2008 and an increase of $0.77 from December 31, 2007. With the deterioration of credit market conditions late in the third quarter, the fair value of Capstead's mortgage investments declined by quarter-end as yields on Agency Securities widened relative to benchmark interest rate swap yields. This trend of wider spreads has continued into the fourth quarter. Nearly all of the Company's mortgage investments and all of its interest rate swap agreements are reflected at fair value on the Company's balance sheet and are therefore included in the calculation of book value per common share. The fair value of these positions is impacted by credit market conditions, including changes in interest rates and the availability of financing at reasonable rates and leverage levels (i.e., credit market liquidity). The Company's investment strategy attempts to mitigate these risks by focusing almost exclusively on investments in ARM Agency

Securities, which are considered to have little, if any, credit risk and are collateralized by ARM loans that have interest rates that reset periodically to more current levels. Because of these characteristics, the fair value of Capstead's portfolio is considerably less vulnerable to significant pricing declines caused by credit concerns or rising interest rates compared to portfolios that contain a significant amount of non-agency mortgage securities and/or fixed-rate mortgage securities of any type, which generally results in a more stable book value per common share. The following table progresses book value per common share during 2008:

                                                                                                      Nine Months
                                                               Quarter Ended                             Ended
                                               March 31         June 30         September 30         September 30

Book value per common share, beginning
of period                                     $     9.25        $   9.40        $       10.42        $        9.25
Accretion attributed to capital
transactions                                        0.95            0.35                 0.05                 1.27
Dividend distributions in excess of
earnings                                           (0.02 )         (0.02 )              (0.04 )              (0.08 )
Accumulated other comprehensive income
items:
Change in value of mortgage securities             (0.18 )          0.20                (0.40 )              (0.37 )
Change in value of interest rate swap
agreements held as cash flow hedges                (0.55 )          0.49                (0.01 )              (0.01 )
Termination of cash flow hedge                     (0.05 )             -                    -                (0.04 )

Book value per common share, end of
period                                        $     9.40        $  10.42        $       10.02        $       10.02

Residential Mortgage Investments
Managing a large portfolio of residential mortgage investments consisting primarily of ARM Agency Securities is the core focus of Capstead's investment strategy. As of September 30, 2008, residential mortgage investments totaled $7.89 billion, up from $7.07 billion at year-end, and consisted of over 99% ARM Agency Securities. Residential mortgage investments held by Capstead that are not agency-guaranteed were limited to $20 million as of September 30, 2008 and consist of well-seasoned, low loan to value mortgage loans remaining from a conduit operation operated by the Company in the early 1990's. The Company holds the related credit risk associated with $15 million of these loans, and the rest of these investments are held as collateral for structured financings whereby the related credit risk is borne by the securitizations' bondholders. Agency Securities carry an implied AAA-rating with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008. By focusing on investing in relatively short-duration and highly liquid ARM Agency Securities, declines in fair value caused by increases in interest rates are typically relatively modest compared to investments in longer-duration, fixed-rate assets. These declines can be recovered in a relatively short period of time as the coupon interest rates on the underlying mortgage loans reset to rates more reflective of the then current interest rate environment. Additionally, mortgage coupon resets tend to allow for the recovery of financing spreads diminished during periods of rising interest rates.
Over the last 15 months, deteriorating conditions in the overall credit markets have led to heightened concerns related to credit risk associated with the mortgage loans underlying Agency Securities and the continued availability of sufficient financing to maintain then existing leverage levels for the mortgage REIT industry. From a credit risk perspective, the real or implied federal government guarantee associated with Agency Securities, particularly in light of the recent conservatorship of Fannie Mae and Freddie Mac, helps ensure that fluctuations in value due to credit risk associated with the underlying mortgage loans will be limited. From a market liquidity perspective, Capstead has responded to contracting market liquidity since the fall of 2007 by reducing portfolio leverage through (a) raising nearly $440 million in new common equity capital, (b) selling a limited amount of mortgage securities

and (c) when appropriate, curtailing the replacement of portfolio runoff. As a result of these efforts, the Company has lowered its portfolio leverage from 11.50 to one at June 30, 2007 to 8.36 to one at September 30, 2008, which together with maintaining higher than usual cash balances and expanding the number of lending counterparties with whom the Company routinely does business, has provided the Company with financial flexibility to address challenging credit market conditions.
In connection with these efforts, in March 2008 Capstead sold Agency Securities with a cost basis of $768 million recognizing a loss from portfolio restructuring totaling $1.4 million. No investments were sold during the second and third quarters of 2008. In addition, the number of lending counterparties the Company had borrowings outstanding with has been increased to 17 as of September 30, 2008, up from 14 at year-end and ten at September 30, 2007. Management believes it is appropriate to maintain the Company's leverage near the lower end of its targeted range of eight to 12 times long-term investment capital. However, should market conditions warrant, the Company will take actions similar to those demonstrated over the previous 15 months in order to maintain sufficient financial flexibility to address ongoing market stresses. ARM securities are backed by residential mortgage loans that have coupon interest rates that adjust at least annually to a margin over a current short-term interest rate index or begin doing so after an initial fixed-rate period subject to periodic and lifetime limits, referred to as caps. See "NOTE 4" to the accompanying consolidated financial statements for additional information regarding interest rate resets on the Company's investments. The Company classifies its ARM securities based on each security's average number of months until coupon reset ("months-to-roll"). Current-reset ARM securities have a months-to-roll of 18 months or less while longer-to-reset ARM securities have a months-to-roll of greater than 18 months. As of September 30, 2008, the Company's ARM securities featured the following average current and fully-indexed weighted average coupon rates, net of servicing and other fees ("WAC"), net margins, periodic and lifetime caps, and months-to-roll (dollars in thousands):

                                                            Fully         Average         Average         Average         Months
                                              Net          Indexed          Net          Periodic        Lifetime           To
     ARM Type              Basis*             WAC            WAC          Margins          Caps            Caps            Roll

Current-reset
ARMs:
Agency Securities:
Fannie Mae/Freddie
Mac                    $  4,143,054           5.00 %         4.34 %         1.86 %          4.06 %         10.49 %          4.3
Ginnie Mae                  413,896           5.21           3.28           1.53            1.00            9.97            5.3
Residential
mortgage loans                9,256           5.87           6.09           2.05            1.52           11.15            4.5

                          4,566,206           5.02           4.25           1.83            3.78           10.45            4.4

Longer-to-reset
ARMs:
Agency Securities:
Fannie Mae/Freddie
Mac                       3,287,163           6.07           5.55           1.67            2.69           11.56           37.5

                       $  7,853,369           5.46           4.80           1.76            3.32           10.91           18.2

* Basis represents the Company's investment (unpaid principal balance plus unamortized investment premium) before unrealized gains and losses. As of September 30, 2008, the ratio of basis to related unpaid principal balance for the Company's
ARM securities was 101.30. This table excludes $6 million in fixed-rate residential mortgage loans, $11 million in fixed-rate Agency Securities and $5 million in private residential mortgage pass-through securities held as collateral for structured financings.

Capstead typically finances its current-reset ARM securities using 30-day borrowings that reset monthly at a margin over the federal funds rate although when available at attractive terms, maturities on a portion of these borrowings may be extended to up to 90 days. Prior to the credit market turmoil that began last fall, the Company used longer-dated repurchase arrangements to effectively lock in financing spreads on investments in longer-to-reset ARM securities for a significant portion of the fixed-rate terms of these investments. As of September 30, 2008, these longer-term committed borrowings consisted of a series of repurchase arrangements totaling $1.41 billion with remaining terms of from two to 11 months and an

average maturity of seven months. As of quarter-end, the Company had borrowings with 17 repurchase agreement counterparties, up from 14 at year-end and is pursuing further counterparty relationships. Borrowings under repurchase arrangements supporting residential mortgage investments totaled $7.24 billion at September 30, 2008.
In November 2007 the Company began using two-year term, one- and three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements to effectively lock in fixed rates on a portion of its 30-day borrowings because longer-term committed borrowings were no longer available at attractive terms. Under the terms of the interest rate swap agreements held by Capstead as of September 30, 2008, the Company pays fixed rates of interest averaging 3.44% on notional amounts totaling $1.90 billion with an average maturity of 16 months. Variable payments received by the Company under these agreements tend to offset interest accruing on a like amount of the Company's 30-day borrowings leaving the fixed-rate payments to be paid on the swap agreements as the Company's effective borrowing rate, subject to certain adjustments. The Company intends to continue to manage interest rate risk associated with holdings of longer-to-reset ARM securities by utilizing suitable derivative financial instruments ("Derivatives") such as interest rate swap agreements as well as longer-dated committed borrowings if available at attractive terms. Acquisitions of Agency Securities during the three and nine months ended September 30, 2008 totaled $511 million and $2.80 billion in principal amount, respectively, while portfolio runoff totaled $411 million and $1.20 billion for the same period. Portfolio runoff declined modestly to an annualized rate of 19% during the third quarter of 2008 compared to 20% during the second quarter of 2008 and year-to-date, reflecting the current difficult conditions in the residential mortgage lending environment, including national trends toward declining home values and tighter mortgage loan underwriting standards. These factors are expected to continue to plague homeowners seeking to sell their homes or refinance their mortgages, which may allow the Company to experience more favorable runoff trends than would otherwise occur. Since Capstead typically purchases investments at a premium to the asset's unpaid principal balance, high levels of mortgage prepayments can put downward pressure on ARM security yields because the level of mortgage prepayments impacts how quickly these investment premiums are written off against earnings as portfolio yield adjustments.
Commercial Real Estate-related Assets
Since the spring of 2000 Capstead periodically augmented its core investment strategy with investments in credit-sensitive commercial real estate-related assets that can earn attractive risk-adjusted returns. Over the years these alternative investments have included a portfolio of net-leased senior living centers as well as commercial mortgage securities and subordinated loans supported by interests in commercial real estate. In all instances the overall level of capital committed to these investments has been relatively modest, primarily because the related risk-adjusted returns on additional investments have not been compelling.
In light of overall credit market conditions, management has concluded that it will not pursue investments in commercial real estate-related assets beyond its existing investments in order to focus its efforts on the Company's core portfolio of ARM Agency Securities. As of September 30, 2008, Capstead's investments in commercial real estate-related assets consisted of (a) $5 million in subordinated loans to a Dallas, Texas-based developer scheduled to pay off over the next nine months through townhome and land sales, pursuant to an extension entered into during the third quarter, and (b) $38 million in subordinated loans on a luxury hotel property in the Caribbean that matured October 9, 2008. A pre-workout letter reserving all rights of the lending group was executed prior to maturity to allow additional time to reach a resolution for the financing of this property.

Utilization of Long-term Investment Capital and Potential Liquidity Capstead finances a majority of its holdings of residential mortgage securities with investment banking firms and commercial banks using repurchase arrangements with the balance, or margin, supported by the Company's long-term investment capital. Long-term investment capital includes preferred and common equity capital as well as unsecured borrowings, net of the Company's investment in related statutory trusts accounted for as unconsolidated affiliates. Assuming potential liquidity is available, borrowings under repurchase arrangements can be increased or decreased on a daily basis to meet cash flow requirements and otherwise manage capital resources efficiently. Consequently, the actual level of cash and cash equivalents carried on the Company's balance sheet is less important than the potential liquidity inherent in the Company's investment portfolios. Potential liquidity is affected by, among other things, real (or perceived) changes in market value of assets pledged; principal prepayments; collateral requirements of the Company's lenders; and general conditions in the investment and commercial banking, mortgage finance and real estate industries. Future levels of portfolio leverage will be dependent upon many factors, including the size and composition of the Company's investment portfolios (see "Liquidity and Capital Resources").
Capstead's utilization of long-term investment capital and its estimated potential liquidity were as follows as of September 30, 2008 in comparison with December 31, 2007 (in thousands):

                                                                          Repurchase
                                                                         Arrangements
                                                                         and Similar             Capital               Potential
                                                Investments (a)           Borrowings           Employed (a)          Liquidity (a)

Residential mortgage securities                $       7,892,891        $    7,242,848        $      650,043        $       240,382
Commercial real estate-related assets                     43,221                     -                43,221                      -

                                               $       7,936,112        $    7,242,848               693,264                240,382

Other assets, net of other liabilities                                                               205,141                137,475
Second quarter common dividend                                                                       (32,024 )              (32,024 )(b)

                                                                                              $      866,381        $       345,833


Balances as of December 31, 2007               $       7,108,719        $    6,500,362        $      660,895        $       371,196

(a) Investments are stated at carrying amounts on the Company's balance sheet, which generally reflects management's estimate of fair value as of the indicated dates. Potential liquidity is based on management's estimate of the fair value of unpledged mortgage securities as of the indicated dates adjusted for other sources
(uses) of liquidity, cash and cash equivalents, and dividends payable.

(b) The third quarter common dividend was declared September 11, 2008 and paid October 20, 2008 to stockholders of record as of September 30, 2008.

In order to prudently and efficiently manage its liquidity and capital resources, Capstead attempts to maintain sufficient liquidity reserves to fund margin calls (requirements to pledge additional collateral or pay down borrowings), including margin calls resulting from monthly principal payments (that are not remitted to the Company for 20 to 45 days after any given month-end), and anticipated declines in the market value of pledged assets under stressed market conditions. During the third quarter the Company maintained its portfolio leverage at the lower end of its targeted range of eight to twelve times long-term investment capital and maintained higher than usual cash balances, which has provided the Company with financial flexibility to address challenging credit market conditions. Management believes it is appropriate to maintain the Company's leverage near the lower end of its targeted range of eight to 12 times long-term investment capital. However, should market conditions warrant, the Company will take actions similar to those demonstrated over the previous 15 months in order to maintain sufficient financial flexibility to address ongoing market stresses.

Accounting for Seller-Financed Acquisitions of Mortgage Securities Capstead generally pledges its Mortgage securities and similar investments as collateral under repurchase arrangements and a portion of the Company's acquisitions may initially be financed with sellers. The Company records such assets and the related borrowings gross on its balance sheet, and the corresponding interest income and interest expense gross on its income statement. In addition, the asset is typically a security held available-for-sale, and any change in fair value of the asset is recorded as a component of Accumulated other comprehensive income. In February 2008 the . . .