Book Value per Common Share
Nearly all of Capstead'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. The Company's investment strategy attempts to mitigate these risks by focusing almost exclusively on investments in 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 and/or fixed-rate mortgage securities of any type, which generally results in a more stable book value per common share. As of March 31, 2009, Capstead's book value per common share (total stockholders' equity, less liquidation preferences of the Company's Series A and B preferred shares, divided by common shares outstanding) was $10.34, an increase of $1.20 from December 31, 2008. The following table progresses book value per common share during the quarter ended March 31, 2009:

                                                                             Per Common
                                                                               Share

Book value, beginning of quarter                                            $       9.14
Accretion attributed to capital transactions                                        0.01
Earnings in excess of dividend distributions                                        0.02
Improvement in value of mortgage securities classified as
available-for-sale                                                                  1.04
Improvement in value of interest rate swap agreements designated as
cash flow hedges                                                                    0.13

Book value, end of quarter                                                  $      10.34

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 March 31, 2009, residential mortgage investments totaled $7.60 billion, consisting of over 99% ARM Agency Securities. This compares with residential mortgage investments totaling $7.46 billion as of December 31, 2008. Non-agency-guaranteed residential mortgage investments held by Capstead were limited to $18 million as of March 31, 2009 consisting 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 $14 million of these loans, and the remainder 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, if any, credit risk because the timely payment of principal and interest is guaranteed by the GSEs, which are federally chartered corporations, or an agency of the federal government, Ginnie Mae. The September 2008 conservatorship of the GSEs by their federal regulator, and related capital commitments to the GSEs made by the U.S. Treasury, have served to help alleviate market concerns regarding the ability of the GSEs to fulfill their guarantee obligations. By focusing on investing in relatively short-duration 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 are generally recoverable 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 allowing for the potential recovery of financing spreads diminished during periods of rising interest rates.

ARM securities are backed by residential mortgage loans that have coupon interest rates that adjust at least annually to more current interest rates or begin doing so after an initial fixed-rate period. After the initial fixed-rate period, if applicable, mortgage loans underlying ARM securities either
(i) adjust annually based on specified margins over the one-year Constant Maturity U.S. Treasury Note Rate ("CMT") or the one-year London interbank offered rate ("LIBOR"), (ii) adjust semiannually based on specified margins over six-month LIBOR, or (iii) adjust monthly based on specified margins over indexes such as one-month LIBOR or the Eleventh District Federal Reserve Bank Cost of Funds Index, or over a rolling twelve month average of the one-year CMT index, usually subject to periodic and lifetime limits on the amount of such adjustments during any single interest rate adjustment period and over the contractual term of the loans. 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 March 31, 2009, the Company's ARM securities featured the following characteristics (dollars in thousands):

                                                            Fully          Average         Average         Average        Months
                                             Net           Indexed           Net          Periodic        Lifetime          To
     ARM Type            Basis (a)         WAC (b)         WAC (b)         Margins          Caps            Caps           Roll

Current-reset ARMs:
Agency Securities:
Fannie Mae/Freddie
Mac                     $ 4,419,893            4.35 %          3.01 %          1.83 %          3.83 %         10.49 %         4.5
Ginnie Mae                  381,438            4.70            2.16            1.53            1.00            9.99           5.5
Residential
mortgage loans                8,812            5.11            3.77            2.05            1.53           11.14           5.2

                          4,810,143            4.38            2.94            1.81            3.61           10.45           4.6

Longer-to-reset
ARMs:
Agency Securities:
Fannie Mae/Freddie
Mac                       2,691,564            6.13            3.41            1.68            2.79           11.61          32.6

                        $ 7,501,707            5.00            3.11            1.76            3.31           10.87          14.6

(a) Basis represents the Company's investment (unpaid principal balance plus unamortized investment premium) before unrealized gains and losses. As of March 31, 2009, the ratio of basis to related unpaid principal balance for the Company's
ARM securities was 101.25. This table excludes $9 million in fixed-rate Agency Securities, $5 million in fixed-rate residential mortgage loans and $4 million in private residential mortgage pass-through securities held as collateral for structured financings.

(b) Net WAC, or weighted average coupon, is presented net of servicing and other fees. Fully indexed WAC represents the coupon upon one or more resets using interest rate indexes as of March 31, 2009 and the applicable net margin.

Capstead typically finances its current-reset ARM securities using 30-day borrowings under uncommitted repurchase arrangements with commercial banks and other financial institutions that are re-established monthly, although terms on a portion of these borrowings may be extended at times to manage market liquidity conditions or to take advantage of attractive terms. Interest rates on these borrowings are based on prevailing rates corresponding to the terms of the borrowings. Prior to the credit market turmoil that began in August 2007, 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 March 31, 2009, these longer-term borrowings consisted of a series of repurchase arrangements totaling $732 million with an average rate of 5.13% that mature over the next five months. As of March 31, 2009, borrowings under repurchase arrangements totaled $6.85 billion.
In November 2007 the Company began using two-year term, one- and three-month LIBOR-indexed, pay-fixed, receive-variable, interest rate swap agreements entered into with three large commercial banks in lieu of longer-term borrowings. Under the terms of the interest rate swap agreements held by Capstead as of March 31, 2009, the Company pays fixed rates of interest averaging 3.08% on notional amounts totaling $2.30 billion with an average maturity of 12 months, including agreements with notional amounts totaling $900 million that terminate in November and December 2009. Variable payments received by the Company under these agreements provide an offset to interest accruing on a like amount of the

Company's 30- to 90-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 including the effects of measured hedge ineffectiveness and the spread between variable rates on the swap agreements and related actual borrowing rates. 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.
In response to deteriorating credit market conditions during 2007 and 2008, Capstead reduced its portfolio leverage during those periods by raising a significant amount of new common equity capital, selling a limited amount of Agency Securities and, when appropriate, curtailing the replacement of portfolio runoff. In addition, the Company increased the number of lending counterparties with which it had borrowings outstanding to 16 as of March 31, 2009, up from ten in September 2007. During the first quarter of 2009, the Company resumed its usual practice of replacing portfolio runoff and deploying new common equity capital. Acquisitions for the quarter totaled $361 million in principal amount with a net WAC of 4.75% and a purchase yield of 3.30%, while portfolio runoff totaled $286 million in principal amount, resulting in an increase in portfolio of $75 million. Combined with a $66 million improvement in pricing of Agency Securities classified as available-for-sale, the Company's holdings of residential mortgage investments increased $141 million during the quarter ended March 31, 2009. Total portfolio runoff declined to an average annualized rate of 14.3% during the first quarter from an average rate of 18.4% throughout 2008. This reflects the pronounced contraction seen in residential mortgage lending, largely because of national trends toward declining home values and tighter mortgage loan underwriting standards. 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 investment premiums are written off against earnings as portfolio yield adjustments. Commercial Real Estate-related Assets
In prior years Capstead periodically augmented its core investment strategy with investments in credit-sensitive commercial real estate-related assets that could 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; however, the overall level of capital committed to these investments has been relatively modest. In light of overall credit market conditions, management has concluded that it will not pursue additional investments in commercial real estate-related assets in order to focus its efforts on the Company's core portfolio of ARM Agency Securities. As of March 31, 2009, Capstead's remaining investments in commercial real estate-related assets consisted of (a) $5 million in subordinated loans to a Dallas, Texas-based developer expected to be repaid through townhome and land sales, and (b) $38 million in subordinated loans collateralized by a Four Seasons hotel in the Nevis West Indies that matured October 9, 2008 and was subsequently damaged by Hurricane Omar. This property has wind and business interruption insurance coverage, which together with related reserves, should be sufficient to repair the hotel for reopening late in 2009. In January 2009 the Company filed suit against the loan servicer and a lien holder subordinate to Capstead, to enforce the Company's rights under the loan documents. These rights include, among other items, the right to be named the controlling holder representing the lending group in reaching a resolution for the financing of this property. Included in receivables and other assets is $808,000 in accrued interest associated with these investments. In light of deteriorating commercial real estate market conditions and the past due status of these loans, no interest was recognized during the quarter ended March 31, 2009. Management has concluded that the Company is likely to recover its investments in these loans and no impairment charges were deemed appropriate at March 31, 2009.

Utilization of Long-term Investment Capital and Potential Liquidity Capstead finances a majority of its holdings of residential mortgage securities with commercial banks and other financial institutions using borrowings under repurchase arrangements supported by the Company's long-term investment capital. Assuming potential liquidity is available, borrowings under repurchase agreements generally can be increased or decreased on a daily basis to meet cash flow requirements and otherwise manage capital resources efficiently. Consequently, the Company's potential liquidity inherent in its investment portfolios is as important as the actual level of cash and cash equivalents carried on the balance sheet. 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 commercial banking and mortgage finance industries. Future levels of portfolio leverage will be dependent upon many factors, including the size and composition of the Company's investment portfolio (see "Liquidity and Capital Resources.") Capstead's utilization of long-term investment capital and its estimated potential liquidity were as follows as of March 31, 2009 in comparison with December 31, 2008 (in thousands):

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


Residential mortgage securities                 $       7,596,198        $    6,849,684        $      746,514        $       323,034
Commercial real estate-related assets                      43,874                     -                43,874                      -

                                                $       7,640,072        $    6,849,684               790,388                323,034

Other assets, net of other liabilities                                                                183,978                116,852
First quarter common dividend                                                                         (35,501 )              (35,501 ) (b)

                                                                                               $      938,865        $       404,385


Balances as of December 31, 2008                $       7,499,530        $    6,751,500        $      860,428        $       302,931

(a) Investments are stated at carrying amounts on the Company's balance sheet. Potential liquidity is based on maximum amounts of borrowings available under existing uncommitted repurchase arrangements considering management's estimate of the fair value of related collateral as of the indicated dates adjusted for other sources
(uses) of liquidity such as cash and cash equivalents and dividends payable.

(b) The first quarter 2009 common dividend was declared March 12, 2009 and paid April 20, 2009 to stockholders of record as of March 31, 2009.

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), as well as anticipated declines in the market value of pledged assets under stressed market conditions.
In response to deteriorating market conditions experienced the latter part of 2007 and in 2008, Capstead reduced its portfolio leverage by raising new common equity capital, selling a limited amount of mortgage securities, and, when appropriate, curtailing the replacement of portfolio runoff. As a result of these efforts, the Company lowered its portfolio leverage from 11.50 to one at June 30, 2007 to 7.85 to one by December 31, 2008. Portfolio leverage declined further to 7.30 to one by the end of the first quarter of 2009, primarily due to higher portfolio pricing since year-end. Together with maintaining higher than usual cash balances and expanding the number of lending counterparties with whom the Company routinely does business, these steps have increased the Company's financial flexibility to address challenging credit market conditions. Management currently believes it is appropriate to maintain the Company's leverage at or below the low end of its targeted range of eight to 12 times long-term investment capital and will take actions similar to those described above in order to maintain sufficient financial flexibility should market conditions warrant.

Accounting for Seller-Financed Acquisitions of Mortgage Securities On January 1, 2009, Capstead adopted the Financial Accounting Standards Board's Staff Position FAS140-3 "Accounting for Transfers of Financial Assets and Repurchase Financing Transactions"("FSP140-3"). Under FSP140-3, certain seller-financed acquisitions of mortgage investments entered into after December 31, 2008 will not qualify as acquisitions if the related borrowings under repurchase arrangements are considered sufficiently linked to the acquisition transaction. Any such seller-financed acquisitions that are deemed to be sufficiently linked will generally be reported net of related financings at fair value with related changes in fair value reported in earnings until such time as the assets are no longer financed with the sellers. No such linked acquisitions have occurred during the quarter ended March 31, 2009; therefore, implementing FSP140-3 has not had any effect on Capstead's results of operations, taxable income or financial condition.

                             RESULTS OF OPERATIONS

                                                                      Quarter Ended March 31
                                                                      2009               2008

Income statement data (dollars in thousands, except per
share data):
Interest income:
Mortgage securities and similar investments                       $     87,884         $ 106,351
Other                                                                      217               804

                                                                        88,101           107,155

Interest expense:
Repurchase arrangements and similar borrowings                         (39,957 )         (69,306 )
Unsecured borrowings                                                    (2,187 )          (2,187 )

                                                                       (42,144 )         (71,493 )

                                                                        45,957            35,662

Other revenue (expense):
Loss from portfolio restructurings                                           -            (1,408 )
Miscellaneous other revenue (expense)                                     (105 )              39
Incentive compensation expense                                          (1,134 )          (2,250 )
General and administrative expense                                      (2,707 )          (1,961 )

                                                                        (3,946 )          (5,580 )

                                                                        42,011            30,082
Equity in earnings of unconsolidated affiliates                             65                65

Net income                                                        $     42,076         $  30,147

Net income available to common stockholders, after preferred
share dividends                                                   $     37,015         $  25,083

Diluted earnings per common share                                 $       0.58         $    0.53
Average diluted shares outstanding:                                     72,873            56,413
Key portfolio statistics (dollars in millions):
Average yields:
Mortgage securities and similar investments                               4.68 %            5.68 %
Other                                                                     0.70              3.88
Total average yields                                                      4.61              5.66
Average borrowing rates:
Repurchase arrangements and similar borrowings                            2.35              3.96
Unsecured borrowings                                                      8.49              8.49
Total borrowing rates                                                     2.45              4.03
Financing spreads                                                         2.16              1.63
Net yield on total interest-earning assets                                2.44              1.89
Average portfolio runoff rate                                            14.28             18.98
Average interest-earning assets and interest-bearing
liabilities:
Mortgage securities and similar investments                       $      7,517         $   7,494
. . .