NOTE 11 ¾ COMPENSATION PROGRAMS

The compensation committee of Capstead’s board of directors (the “Committee”) administers all compensation programs for employees including salaries and related programs, short-term incentive compensation and long-term incentive compensation, including equity-based awards, as well as other benefit programs.

Performance-based Cash Compensation Program

In 2008, the Committee installed a performance-based cash compensation program for executive officers that provides for payments equal to the per share dividend declared on the Company’s common stock multiplied by a notional amount of non-vesting or “phantom” common shares (“Dividend Equivalent Rights”). Dividend Equivalent Rights are not attached to any stock or option awards and only have the right to receive the same cash distributions per share that the Company’s common stockholders are entitled to receive during the term of the grants, subject to certain conditions, including continuous service.

Dividend Equivalent Rights issued and outstanding at September 30, 2013 and related compensation costs for the indicated periods were as follows:

Month of Grant*	Total Grant		Quarter Ended September 30, 2013		Nine Months Ended September 30, 2013
July 2008		225,000	$	70,000	$	209,000
July 2009		225,000		70,000		209,000
July 2010		60,000		19,000		56,000
August 2011		72,000		22,000		67,000
July 2012		72,000		22,000		67,000
		654,000	$	203,000	$	608,000

* All grants expire July 1, 2015 unless extended by the Committee.

Short-Term Incentive Compensation

To provide employees with an appropriate performance-based annual incentive compensation opportunity, each year the Committee approves an incentive formula for the award of annual incentive compensation that is directly linked with the performance of the Company. The formula used in recent years accomplished this by establishing an incentive pool equal to a percentage participation in the Company’s earnings in excess of a pre-established performance threshold or benchmark, subject to a maximum amount, or cap, available to be paid in any one year. Notwithstanding the calculated amount of the incentive pool, the Committee determined (i) the amount actually awarded, (ii) its allocation between executive officers and other employees, and (iii) the form of payment (e.g., cash or equity awards). The Committee recently adopted a new short-term incentive program effective July 1, 2013 that determines levels of incentive compensation based on a number of relative performance metrics measured against the Company’s peers in the mortgage REIT industry. Included in third quarter results is the estimated year-to-date effect of this program change. Short-term incentive compensation accruals totaling $1.6 million and $3.6 million at September 30, 2013 and 2012, respectively are included in Accounts payable and accrued expenses.

Long-term Equity-based Awards

The Company sponsors equity-based award plans to provide for the issuance of stock awards, option awards and other long-term equity-based awards to directors and employees (collectively, the “Plans”). At September 30, 2013, the Plans had 519,987 common shares remaining available for future issuance.

In 2008 the Company implemented a performance-based stock award program in lieu of its previous practice of issuing service-based awards to employees. As this program is currently configured, the first 50% of awards granted in December of each year vest provided certain performance criteria pertaining to a three-year measurement period that starts at the beginning of the following calendar year are met. The remaining 50% vests provided performance criteria pertaining to a three-year measurement period beginning one year later are met. If the performance criteria are not met at the end of a three-year measurement period, vesting will be deferred and a new three-year measurement period will be established to include the subsequent year, up to and including the seventh calendar year after the year of grant. Any remaining unvested awards will expire if the performance criteria for the final three-year measurement period are not met. The performance criteria establishes an annualized threshold return on the Company’s long-term investment capital, subject to certain adjustments, that must be exceeded for the awards to vest, equal to the greater of 8.0% or the average 10-year U.S. Treasury rate plus 200 basis points.

The following table includes performance-based stock awards issued to employees with related measurement period information at September 30, 2013:

						Final		Remaining Shares with
	Grant Date		Total			Measurement		Initial Measurement Periods
Year of	Fair Value		Original			Period Ends		Ending December 31
Grant	Per Share		Grants			December 31		2013		2014		2015		2016
2008	$	10.18		140,658	^(a)		n/a		–		–		–		–
2009		14.33		110,917	^(b)		2016		52,915		–		–		–
2010		12.44		128,766			2017		61,508		61,499		–		–
2011		12.72		132,490			2018		–		63,722		63,718		–
2012		11.67		145,399			2019		–		–		69,853		69,849

(a)

The performance criteria for the three-year measurement periods ending December 31, 2012 and 2011 were met resulting in the vesting of 67,599 shares associated with the first 50% of this grant in February 2012 and 67,595 shares associated with the second 50% of this grant in January 2013.

(b)

The performance criteria for the first three-year measurement period ending December 31, 2012 was met resulting in the January 2013 vesting of 53,431 shares associated with the first 50% of this grant.

The following table includes service-based stock awards issued to directors and employees with related vesting and forfeiture information (subject to certain restrictions, principally continuous service), at September 30, 2013:

	Grant Date		Total						Remaining Shares
Year of	Fair Value		Original		As of September 30, 2013				Scheduled to Vest During:
Grant	Per Share		Grants		Vested		Forfeited		2013*		2014
2007	$	12.93		156,000		121,004		12,832		22,497		22,164
2008		12.87		6,000		6,000		–		–		–
2009		11.39		6,000		6,000		–		–		–
2010		11.64		12,000		12,000		–		–		–
2011		13.23		24,000		24,000		–		–		–
2012		13.59		29,000		29,000		–		29,000		–
2013		13.02		28,000		–		–		–		28,000

The 2007 grant shares vested in January 2013 and the 2012 grant shares vested in April 2013.

Performance-based and service-based stock award activity for the nine months ended September 30, 2013 is summarized below:

				Weighted Average
	Number of			Grant Date
	Shares			Fair Value
Unvested stock awards outstanding at December 31, 2012		657,720		$	12.48
Grants		28,000			13.02
Vestings		(172,523	)		12.41
Forfeitures		(19,969	)		12.65
Unvested stock awards outstanding at September 30, 2013		493,228			12.53

During the quarter and nine months ended September 30, 2013, the Company recognized in Salaries and benefits $470,000 and $1,345,000, respectively, related to amortization of the grant date fair value of employee performance-based and service-based stock awards. The amounts amortized for these periods assumed that performance criteria, if applicable, would continue to be met for related initial measurement periods. In addition, the Company recognized in Other general and administrative expense $92,000 and $295,000 related to amortization of the grant date fair value of service-based director stock awards during the quarter and nine months ended September 30, 2013, respectively. The 2009 performance-based stock awards and all service-based stock awards receive dividends on a current basis without risk of forfeiture if the related awards do not vest. Performance-based awards granted subsequent to 2009 defer the payment of dividends accruing during the vesting period until vesting and if the related awards do not vest these accrued dividends will be forfeited. At September 30, 2013 dividends payable pertaining to these awards totaled $1.1 million and are included in Common stock dividend payable. Unrecognized compensation expense for unvested stock awards totaled $3.1 million as of September 30, 2013, to be expensed over a weighted average period of 1.2 years (assumes minimal employee attrition and applicable performance criteria are met for related initial measurement periods).

Option awards currently outstanding have contractual terms and vesting requirements at the grant date of ten years and were issued with strike prices equal to the quoted market prices of the Company’s common shares on the date of grant. The fair value of option awards was estimated on the date of grant using a Black-Scholes option pricing model. The Company estimated option exercises, expected holding periods and forfeitures based on past experience and expectations for option performance and employee or director attrition. Risk-free rates were based on market rates for the expected life of the options. Expected dividends were based on historical experience and expectations for future performance. Expected volatility factors were based on historical experience. No option awards have been granted since 2010. Option award activity for the nine months ended September 30, 2013 is summarized below:

	Number of			Weighted Average
	Shares			Exercise Price
Option awards outstanding at December 31, 2012		97,500		$	11.63
Exercises		(5,000	)		9.56
Option awards outstanding at September 30, 2013		92,500			11.74

Exercisable option awards outstanding as of September 30, 2013 totaled 92,500 shares with a weighted average remaining contractual term of 4.0 years, an average exercise price of $11.74 and an aggregate intrinsic value of $56,000. The total intrinsic value of option awards exercised during the nine months ended September 30, 2013 was $17,000.

Other Benefit Programs

Capstead sponsors a qualified defined contribution retirement plan for all employees and a nonqualified deferred compensation plan for certain of its officers. In general the Company matches up to 50% of a participant’s voluntary contribution up to a maximum of 6% of a participant’s compensation and makes discretionary contributions of up to another 3% of compensation regardless of participation in the plans. Company contributions are subject to certain vesting requirements. During the quarter and nine months ended September 30, 2013, the Company recognized in Salaries and benefits $119,000 and $207,000 related to contributions to these plans, respectively.