Capital Raising Activity
During the quarter and nine months ended September 30, 2009 Capstead issued 5,147,000 and 5,835,000 common shares at average prices of $14.00 and $13.82 per share ($13.85 and $13.66 per share, net of expenses), respectively, under the Company's continuous offering program. These issuances raised $71 million and $80 million in new common equity capital, after underwriting discounts and offering expenses, respectively. 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.
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 (total stockholders' equity, less liquidation preferences of the Company's Series A and B preferred shares, divided by common shares outstanding). The fair value of these positions is impacted by 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. The following table progresses book value per common share for the periods indicated:

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

Book value per common share, beginning
of period                                     $     9.14        $  10.34        $       11.48        $        9.14
Accretion attributed to capital
transactions                                        0.01            0.02                 0.17                 0.38
Earnings in excess of dividend
distributions                                       0.02            0.01                    -                 0.01
Dividend distributions in excess of
earnings                                               -               -                (0.02 )                  -
Improvement in value of mortgage
securities classified as
available-for-sale                                  1.04            0.96                 0.44                 2.28
Improvement in value of interest rate
swap Agreements designated as cash flow
hedges                                              0.13            0.15                 0.14                 0.40

Book value per common share, end of
period                                        $    10.34        $  11.48        $       12.21        $       12.21


Increase in book value for the indicated
period                                        $     1.20        $   1.14        $        0.73        $        3.07

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, 2009, residential mortgage investments totaled $7.87 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 $16 million as of September 30, 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 $12 million of these loans, with the remainder 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 largely 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 September 30, 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                     $ 5,338,114          3.77 %          2.54 %          1.81 %          3.37 %         10.46 %         5.2
Ginnie Mae                  346,741          4.22            1.91            1.53            1.00           10.01           5.3
Residential
mortgage loans                8,558          4.41            2.67            2.05            1.53           11.13           4.5

                          5,693,413          3.80            2.50            1.80            3.22           10.44           5.2

Longer-to-reset
ARMs:
Agency Securities:
Fannie Mae/Freddie
Mac                       1,991,317          6.15            2.58            1.66            1.97           11.57          29.1

                        $ 7,684,730          4.41            2.52            1.76            2.90           10.73          11.4

(a) Basis represents the Company's investment (unpaid principal balance plus unamortized investment premium) before unrealized gains and losses. As of September 30, 2009, the ratio of basis to related unpaid principal balance for the Company's
ARM securities was 101.33. This table excludes commercial investments, fixed-rate residential mortgage investments and collateral for structured financings.

(b) Net WAC, or weighted average coupon, is presented net of servicing and other fees and as such, represents the cash yield earned by the Company before amortization of investment premiums. Fully indexed WAC represents the coupon upon one or more resets using interest rate indexes as of September 30, 2009 and the applicable net margin.

Capstead typically finances its residential mortgage investments 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 market turmoil that began in August 2007, the Company routinely made use of longer-dated repurchase arrangements to mitigate exposure to higher short-term interest rates, particularly as it pertains to

investments in longer-to-reset ARM Agency Securities. The remaining $557 million of these longer-term committed borrowings with an average interest rate of 5.17% matured in August 2009. The Company's borrowings under repurchase arrangements as of September 30, 2009 consisted of $6.99 billion of primarily 30-day borrowings with 16 counterparties at average rates of 0.37%.
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 four large commercial banks in lieu of longer-term borrowings. Under the terms of the interest rate swap agreements held by Capstead as of September 30, 2009, the Company pays fixed rates of interest averaging 2.76% on notional amounts totaling $2.80 billion with an average maturity of nine months, including agreements with notional amounts totaling $900 million and average fixed rates of 4.03% that terminate in November and December 2009, $800 million with average fixed rates of 2.84% that terminate during the quarter ended March 31, 2010; $200 million with average fixed rates of 3.17% that terminate during the quarter ended June 30, 2010; and $900 million with average fixed rates of 1.33% that terminate between January and September 2011. 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.
After consideration of these swap positions, the Company's portfolio and related borrowings under repurchase arrangements had durations of approximately eight and four months, respectively, for a net duration gap of approximately four months. Duration is a measure of market price sensitivity to interest rate movements. For instance, a 12 month duration infers that a position should change in value by one percent with a one percent change in interest rates, subject to other market variables and changes in market conditions. The Company intends to continue to manage interest rate risk 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 market conditions experienced the latter part of 2007 and in 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 uses on a regular basis. During 2009, the Company resumed its usual practice of replacing portfolio runoff and deploying new common equity capital into additional holdings of ARM Agency Securities, with a focus on acquiring current-reset ARM securities. Additionally, the Company has experienced a significant increase in the fair value of its portfolio. Year-to-date, acquisitions (consisting primarily of current-reset ARM Agency Securities) totaled $1.31 billion in principal amount with a net WAC of 4.28% and a purchase yield of 2.95%, while portfolio runoff totaled $1.07 billion in principal amount. Combined with a $157 million improvement in pricing of Agency Securities classified as available-for-sale, the Company's holdings of residential mortgage investments increased $411 million in 2009. Total runoff for residential mortgage investments increased during the current quarter to an average annualized rate of 21.7%, while averaging 17.6% year-to-date compared to 18.4% throughout 2008. While trending higher from near-record low levels experienced earlier this year, prepayment rates remain at relatively favorable levels and continue to be restrained by 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 Investments
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. In light of overall credit market conditions, in 2008 management 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. Investments in commercial loans and securities as of September 30, 2009 consisted of $6.0 million in subordinated loans to a Dallas, Texas-based townhome developer expected to be repaid primarily through unit sales, $38.4 million in subordinated loans collateralized by the Four Seasons hotel in Nevis, West Indies, and $10.0 million face amount of AAA-rated senior notes issued by one of the Company's lending counterparties.
Regarding the townhome development loans, in January 2009 the Company began making advances for operating expenses on behalf of the borrower who is in financial difficulty. These advances totaled $290,000 and $880,000 for the quarter and nine months ended September 30, 2009. The Company curtailed recognizing interest on these loans effective January 1, 2009 and in June the Company recognized in Miscellaneous other revenue (expense) a $750,000 impairment charge, increasing its allowance for possible loan losses to $1.0 million, primarily because of slow sales and reduced pricing of units collateralizing the townhome development loans. No additional impairment charges were recognized during the quarter ended September 30, 2009 relative to this investment.
The financing for the Nevis property matured in October 2008 and one week later it was significantly damaged by Hurricane Omar, forcing closure of the hotel. The property has wind and business interruption insurance coverage, which together with related reserves, should be sufficient to fund most rebuilding and reopening costs necessary to reopen the hotel. In September 2009 the Company settled a legal dispute with a junior lien holder, subsequently dropped its lawsuit against the lien holder and the loan servicer and, pursuant to the settlement, is now acting as controlling holder representing the lending group. The Company is currently investigating the lending group's options for reopening the hotel and achieving an optimal recovery under the circumstances. On January 1, 2009 the Company curtailed recognizing interest and during 2009 no impairment charges have been recognized relative to this investment. The senior notes were issued in July 2009 pursuant to a larger private placement by two large commercial banks of senior and junior notes of a lending counterparty. The notes, which bear interest at 10.0% per annum, payable monthly, mature on December 15, 2010 and are callable by the borrower at par. 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, changes in market value of assets pledged as determined by lending counterparties; principal prepayments; collateral requirements of 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 September 30, 2009 in comparison with December 31, 2008 (in thousands):

                                                                           Related            Capital             Potential
                                                  Investments(a)         Borrowings         Employed(a)          Liquidity(a)
Mortgage securities and similar investments      $      7,920,478        $ 6,992,755        $    927,723        $      456,540

Other assets, net of other liabilities                                                           237,681               168,496
Third quarter common dividend                                                                    (38,695 )             (38,695 )

                                                                                            $  1,126,709        $      586,341


Balances as of December 31, 2008                 $      7,499,249        $ 6,751,500        $    860,428        $      302,931

(a) Investments are stated at carrying amounts on the Company's balance sheets. 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.

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 during these periods 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 6.21 to one by September 30, 2009, due largely to increases in the fair value of the Company's holdings of Agency Securities, along with improved interest rate swap valuations and accretion from capital raises. 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 market conditions. Management currently believes it is appropriate to maintain the Company's leverage 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. Recent Accounting Developments
In June 2008, the Financial Accounting Standards Board ("FASB") issued Staff Position EITF 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities" (now referred to as "ASC 260-10-45" under the FASB Accounting Standards Codification or "ASC"). This pronouncement affects entities that accrue cash dividends on share-based payment awards during the awards' service period when the dividends do not need to be returned if any holder forfeits an award. The FASB concluded that unvested share-based payment awards that contain rights to non-forfeitable dividends are participating securities (i.e. the holders participate in dividends with common stockholders) and must be included in computing basic and diluted earnings per share, if dilutive. ASC 260-10-45 became effective for financial statements beginning January 1, 2009 and requires an entity to retroactively adjust all prior period earnings per share computations to reflect its provisions. Adopting ASC 260-10-45 did not have a material impact on the Company's consolidated financial statements.
On January 1, 2009, Capstead adopted FASB Staff Position FAS140-3 "Accounting for Transfers of Financial Assets and Repurchase Financing Transactions" ("ASC 860-10-40"). Under ASC 860-10-40, 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 . . .