NOTE 11 ¾ COMPENSATION PROGRAMS

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

Annual Incentive Compensation Programs

To provide employees with appropriate performance-based annual incentive compensation opportunities, 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 through June 2013 and in prior years accomplished this by establishing an incentive pool equal to a percentage participation in Capstead’s earnings in excess of a pre-established performance threshold, subject to a maximum amount, or cap. The Committee determined (i) the amount actually awarded, (ii) its allocation among executives and with other employees and (iii) the form of payment (e.g., cash or equity awards). The Committee terminated this absolute return program effective June 30, 2013 and adopted a new annual incentive compensation program for key executives referred to as the “2013 Program.” In connection with terminating the old program, incentive pool amounts totaling $474,000 were distributed subsequent to year-end to all employees.

The 2013 Program determined levels of annual cash incentive compensation based on relative performance metrics measured against the Company’s peers in the mortgage REIT industry and the attainment of individual goals and objectives for participating executives. The relative performance metrics used were relative economic return (change in book value plus dividends) and relative operating efficiency (operating expenses divided by Unsecured borrowings and Stockholders’ equity), calculated for the full year and prorated for the six month period during which the program was effective in 2013. The 2013 Program defined maximum payout percentages based on a multiple of salary for each program metric thereby limiting the amount payable to each participating executive. Actual amounts awarded to participating executives in March 2014 pursuant to the 2013 Program totaled $1.9 million and were based on separate calculations for each performance metric as well as the Committee’s evaluation of the participating executives’ attainment of individual goals and objectives. In addition, $175,000 in annual incentive compensation was awarded to employees not participating in the 2013 Program.

For 2014 the Committee revised the newly-developed annual incentive program to include an absolute economic return performance metric which measures performance against established return levels. Included in Accounts payable and accrued expenses at March 31, 2014 are 2014 annual incentive compensation-related accruals for all employees totaling $492,000. Actual amounts expensed during the first quarter of 2014 were lower as a result of a $175,000 over accrual at December 31, 2013 associated with final settlement of the 2013 annual incentive awards.

Since 2008 the Committee has utilized an additional performance-based cash annual incentive compensation program for key executives that provides for payments equal to per share dividends declared on Capstead’s common stock multiplied by a notional amount of non-vesting or “phantom” common shares (“Dividend Equivalent Rights” or “DERs”). DERs are not attached to any stock or option awards and only represent the right to receive the same cash distributions that the Company’s common stockholders are entitled to receive during the term of the grants, subject to certain conditions, including continuous service. DERs outstanding at March 31, 2014 totaled 654,000 and included in Accounts payable and accrued expenses are first quarter 2014 DER distribution amounts totaling $222,000. Recognized in Annual incentive compensation are $222,000 and $203,000, respectively, related to the DER program for the quarters ended March 31, 2014 and 2013. All grants expire July 1, 2015.

Long-term Equity-based Incentive Awards

Capstead sponsors equity-based award plans to provide for the issuance of stock awards, restricted stock unit awards, option awards and other long-term equity-based incentive awards to directors and employees. As of March 31, 2014, the Company has issued awards reserving for potential future issuance nearly all available shares under its existing plans. A new plan is being submitted for stockholder approval at this year’s annual meeting of stockholders scheduled for May 28, 2014 to allow for the granting of future long-term equity-based incentive awards.

In December 2013 the Committee adopted a new long-term incentive program, and granted key executives a total of 242,505 performance-based restricted stock units which are convertible into common shares following a three-year performance period ending December 31, 2016 depending upon whether, and to what extent, defined performance levels established for certain relative and absolute return performance metrics are met or exceeded. The relative return metrics measure the Company’s performance against its peers in the mortgage REIT industry on the basis of relative economic return and relative total stockholder return (change in stock price plus reinvested dividends). The absolute economic return metric measures performance against established return levels. For conversion purposes, each performance metric is assigned a weighting and the Company’s performance relative to each metric is calculated separately. The actual number of common shares, if any, the units can convert into for each of the metrics can range from one-half of a common share per unit if that metric’s minimum threshold of performance is met, to two common shares per unit if the related maximum performance threshold is met or exceeded, adjusted for the weighting assigned to the metric. If a metric’s minimum performance threshold is not met, no shares are issuable under that metric. Dividends accrue from the date of grant and will be paid in cash when the units convert into common shares based on the number of common shares ultimately issued, if any.

Under a prior absolute return performance-based stock award program, the Committee granted stock awards from 2008 through 2012 to all employees with staggered three-year vesting periods subject to Capstead generating annualized returns on investment capital, (defined for this purpose as Unsecured borrowings and Stockholders’ equity, less accumulated OCI and subject to certain other adjustments), equal to the greater of 8.0% or the average 10-year U.S. Treasury rate plus 200 basis points. If the required returns are not generated during 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 issued under this program will expire if the required returns are not generated for the final three-year measurement period. Information pertaining to absolute return performance-based stock awards issued to employees pursuant to this program is as follows:

							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		Forfeited		December 31			2014		2015		2016
2008 ^(a)	$	10.18		140,658		5,464		n/	a		–		–		–
2009 ^(b)		14.33		110,917		4,571		n/	a		–		–		–
2010 ^(c)		12.44		128,766		5,759		2017			61,499		–		–
2011		12.72		132,490		5,050		2018			63,722		63,718		–
2012		11.67		145,399		5,697		2019			–		69,853		69,849

(a)

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

(b)

The absolute return metrics for the three-year measurement periods ending December 31, 2013 and 2012 were met resulting in the vesting of 52,915 shares associated with the second 50% of this grant in January 2014 and 53,431 shares associated with the first 50% of this grant in January 2013.

(c)

The absolute return metric for the first three-year measurement period ending December 31, 2013 was met resulting in the vesting of 61,508 shares associated with the first 50% of this grant in January 2014.

Information pertaining to service-based stock awards issued to directors and employees (subject to certain restrictions, principally continuous service), is as follows:

Grant Date

Total

Remaining Shares

Year of

Fair Value

Original

As of March 31, 2014

Scheduled to Vest During:

Grant

Per Share

Grants

Vested

Forfeited

2014

2017

2007 ^(a)

12.93

156,000

143,168

12,832

–

2008 ^(b)

12.87

6,000

–

2009 ^(b)

11.39

6,000

–

2010 ^(b)

11.64

12,000

–

2011 ^(b)

13.23

24,000

–

2012 ^(b)

13.59

29,000

–

2013 ^(b)

13.02

28,000

–

28,000

–

2013 ^(c)

12.34

35,703

–

35,703

(a)

The remaining 2007 grant shares vested in January 2014.

(b)

Director stock awards have been granted annually upon election or reelection to the board of directors. These awards vest one year after issuance.

(c)

In December 2013 the Committee granted service-based stock awards to employees that were not awarded performance-based restricted stock units. These awards vest on January 2, 2017.

Performance-based and service-based stock award activity for quarter ended March 31, 2014 is summarized below:

				Weighted Average
	Number of			Grant Date
	Shares			Fair Value
Unvested stock awards outstanding at December 31, 2013		528,931			12.51
Vestings		(136,587	)		13.27
Unvested stock awards outstanding at March 31, 2014		392,344			12.25

During the quarters ended March 31, 2014 and 2013, the Company recognized in Long-term incentive compensation $375,000 and $406,000, 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 metrics, 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 $106,000 related to amortization of the grant date fair value of service-based director stock awards during the quarters ended March 31, 2014 and 2013, respectively. Unrecognized compensation expense for unvested stock awards totaled $2.5 million as of March 31, 2014, to be expensed over a weighted average period of 1.5 years (assumes minimal employee and director attrition and, if applicable, absolute return performance metrics being met for related initial measurement periods).

During the quarter ended March 31, 2014 the Company recognized in Long-term incentive compensation $251,000 related to the performance-based restricted stock units granted in December 2013. A grant date fair value of $12.45 was assigned to each unit based on estimated outcomes for each nonmarket-based performance metric and a Monte Carlo simulation for the relative total stockholder return performance metric. Assuming certain targeted performance levels are achieved and there are no forfeitures, $3.0 million can be expected to be expensed over the related three-year performance period. However, the value associated with the nonmarket-based performance metrics is subject to change over the units’ performance period. Actual expense assuming no forfeitures will range from a minimum of $625,000 (the grant date fair value of the total stockholder return performance metric and assuming no shares are ultimately issued under the terms of these grants because the Company’s performance for all performance metrics was less than the related minimum threshold performance levels) to approximately $5.4 million assuming maximum performance levels are met or exceeded for all performance metrics resulting in the issuance of 485,010 common shares.

All service-based stock awards receive dividends on a current basis without risk of forfeiture if the related awards do not vest. Performance-based restricted stock units and stock awards granted since 2010 defer the payment of dividends accruing between the grant dates and the end of related performance periods. If the restricted stock units do not convert into any common shares or a stock award does not vest, the related accrued dividends will be forfeited. Included in Common stock dividend payable at March 31, 2014 are estimated dividends payable pertaining to these awards totaling $1.2 million.

Option awards currently outstanding have ten-year contractual terms from the grant date 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 and no option award activity occurred during the quarter ended March 31, 2014. Exercisable option awards outstanding at March 31, 2014 totaled 77,500 shares with a weighted average remaining contractual term of 3.4 years, an average exercise price of $11.75 and an aggregate intrinsic value of $92,000.

Other Benefit Programs

Capstead sponsors a qualified defined contribution retirement plan for all employees and a nonqualified deferred compensation plan for certain of its executives. In general the Company matches up to 50% of a participant’s voluntary contribution up to a maximum of 6% of a participant’s salary and short-term incentive compensation and makes discretionary contributions of up to another 3% of such compensation regardless of participation in the plans. Company contributions are subject to certain vesting requirements. During the quarters ended March 31, 2014 and 2013, the Company recognized in Salaries and benefits $64,000 and $63,000 related to contributions to these plans, respectively.