DISCLOSURES REGARDING FAIR VALUES OF FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2012

DISCLOSURES REGARDING FAIR VALUES OF FINANCIAL INSTRUMENTS

NOTE 8 — DISCLOSURES REGARDING FAIR VALUES OF FINANCIAL INSTRUMENTS

The following tables and related discussion provide fair value disclosures as of the indicated balance sheet dates, all of which are determined using Level 2 Inputs in accordance with ASC 820, for Capstead’s financial assets and liabilities, most of which are influenced by changes in, and market expectations for changes in, interest rates and market liquidity conditions, as well as other factors beyond the control of management.

Residential mortgage investments, nearly all of which are mortgage securities classified as available-for-sale, are measured at fair value on a recurring basis. In determining fair value estimates for mortgage securities the Company considers recent trading activity for similar investments and pricing levels indicated by lenders in connection with designating collateral for repurchase arrangements, provided such pricing levels are considered indicative of actual market clearing transactions. Included in the Accumulated other comprehensive income component of Stockholders’ equity are unrealized gains on available-for-sale mortgage securities totaling $369.3 million and $234.7 million as of September 30, 2012 and December 31, 2011, respectively. In determining fair value estimates for longer-term borrowings under repurchase arrangements, the Company considers pricing levels indicated by lenders for entering into new transactions using similar pledged collateral with terms equal to the remaining terms of the longer-term borrowings. In determining fair value estimates for unsecured borrowings, the Company considers current pricing for financial instruments with similar characteristics. Excluded from these disclosures are financial instruments for which the Company’s cost basis is deemed to approximate fair value due primarily to the short duration of these instruments, which are valued using primarily Level 1 measurements, including Cash and cash equivalents, Cash collateral receivable from interest rate swap counterparties, receivables, payables and borrowings under repurchase arrangements with initial terms of 120 days or less. See NOTE 6 for information relative to the valuation of interest rate swap agreements.

Fair value disclosures for financial instruments other than debt securities were as follows (in thousands):

	September 30, 2012				December 31, 2011
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Residential mortgage loans	$	8,230	$	8,400	$	9,148	$	9,300
Interest rate swap agreements		24		24		617		617
Financial liabilities:
Repurchase arrangements with initial terms of greater than 120 days		—		—		47,419		47,400
Unsecured borrowings		103,095		104,900		103,095		104,200
Interest rate swap agreements		41,199		41,199		31,348		31,348

Fair value and related disclosures for debt securities were as follows (in thousands):

	Amortized Cost Basis		Gross Unrealized				Fair Value
			Gains		Losses
As of September 30, 2012
Agency Securities classified as available-for-sale	$	13,929,478	$	369,449	$	167	$	14,298,760
Residential mortgage securities classified as held-to-maturity		6,218		325		—		6,543
As of December 31, 2011
Agency Securities classified as available-for-sale		12,013,804		236,000		1,301		12,248,503
Residential mortgage securities classified as held-to-maturity		7,255		349		—		7,604

	September 30, 2012				December 31, 2011
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Securities in an unrealized loss position:
One year or greater	$	30,966	$	74	$	4,933	$	26
Less than one year		199,206		93		369,226		1,275
	$	230,172	$	167	$	374,159	$	1,301

Managing a leveraged portfolio of primarily ARM Agency Securities is the core focus of Capstead’s investment strategy and management expects these securities will be held until payoff absent a major shift in the Company’s investment focus. Declines in fair value caused by increases in interest rates are typically modest for investments in relatively short-duration ARM Agency Securities 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.

From a credit risk perspective, the real or implied federal government guarantee associated with Agency Securities, particularly in light of the conservatorship of the GSEs by the federal government, helps ensure that fluctuations in value due to credit risk associated with these securities will be limited. Given that (a) any existing unrealized losses on mortgage securities held by the Company are not attributable to credit risk, (b) the Company typically holds its investments to maturity, and (c) it is more likely than not that the Company will not be required to sell any of its investments, none of these investments are considered other-than-temporarily impaired at September 30, 2012.