NOTE 12 — COMPENSATION PROGRAMS

The compensation committee of Capstead’s board of directors (the “Committee”) is responsible for establishing, implementing, and monitoring the Company’s compensation programs and practices. Incentive compensation programs adopted by the Committee for key executives are largely nondiscretionary, formulaic and target-based, utilizing multiple pre-established performance goals (referred to as “metrics”) and defined threshold, target and maximum award amounts determined by reference to established percentages of base salaries. Prior to granting awards, the Committee reviews the Company’s programs, implementing any desired changes in performance metrics and the composition of mortgage REIT industry peer groups used for relative performance metric measurement purposes, as well as establishing each executive’s targeted award opportunity. Equity-based awards and other long-term incentive awards are made pursuant to the Company’s Amended and Restated 2014 Flexible Incentive Plan that was approved by stockholders in May 2014. At December 31, 2016, this plan had 3,688,541 shares of common stock remaining available for future issuances.

Short-Term Incentive Compensation Programs

Under the provisions of Capstead’s annual incentive compensation program, each participating executive has an overall target award opportunity equal to 125% of base salary. Awards are earned based on (a) relative and absolute economic return (change in book value per share of common stock plus common stock dividends divided by beginning book value per share), (b) relative operating cost efficiency (operating expenses divided by Unsecured borrowings and Stockholders’ equity), and (c) attainment of individual goals and objectives. Each performance metric is assigned a weighting and performance relative to each metric is calculated separately. No awards can be earned for performance below defined threshold return levels and awards are capped for performance above defined maximum return levels. Recognized in Compensation-related expense during 2016 and included in Accounts payable and accrued expenses at December 31, 2016 are annual incentive compensation accruals for participating executives (other than the Company’s former CEO), together with discretionary accruals for all other employees, totaling $2.1 million. An additional $655,000 was recognized in Compensation-related expense in March of 2016 related to finalizing 2015 program results. Amounts totaling $3.4 million and $1.2 million were recognized in Compensation-related expense related to annual incentive compensation for all employees during 2015 and 2014, respectively.

The Committee administers an additional performance-based short-term incentive compensation program for key executives that provides for quarterly cash payments equal to per share dividends declared on Capstead’s common stock multiplied by a notional amount of non-vesting shares of common stock (“Dividend Equivalent Rights” or “DERs”). DERs 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. Included in Accounts payable and accrued expenses are fourth quarter 2016 DERs distribution amounts totaling $100,000 that were paid in January 2017 and recognized in Compensation-related expense are $520,000, $746,000 and $889,000 related to the DERs program during 2016, 2015 and 2014, respectively (excludes DER payments earned by the former CEO subsequent to his resignation pursuant to a consulting arrangement).

In January 2017 the Committee adjusted the annual incentive compensation program for 2017 lowering the absolute return threshold and target performance levels to reflect current market conditions. In addition, the Committee re-authorized the DERs program with the same terms and conditions, with adjustments made to the amount of individual grants in recognition of current executive responsibilities.

Long-term Equity-based Awards – Performance-based RSUs

Capstead’s performance-based long-term incentive compensation program for key executives provides for the grant of performance-based RSUs that are convertible into shares of common stock following three-year performance periods, contingent 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 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 defined performance 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 shares of common stock the units can convert into for each of the metrics, if any, can range from one-half of a share per unit if that metric’s threshold level of performance is met, to two shares per unit if the related maximum level of performance is met or exceeded, adjusted for the weighting assigned to the metric. If a metric’s threshold performance level is not met, no shares are issuable under that metric. Dividends accrue from the date of grant and will be paid in cash to the extent the units convert into shares of common stock following completion of related performance periods.

Pursuant to this program, in January 2017, February 2016, January 2015 and December 2013 the Committee granted 148,894, 269,354, 247,512 and 242,505 RSUs with three-year performance periods ending December 31, 2019, 2018, 2017 and 2016, respectively. Initial grant date fair values developed for compensation cost purposes of $10.52, $8.03, $8.83 and $12.45 were assigned to the units of each grant, respectively. RSUs granted to the Company’s former CEO totaling 99,257 granted in 2016 and 93,058 granted in 2015 were forfeited subsequent to year-end with the resulting reversal of compensation cost included in Separation of service charge in 2016. RSUs granted to a departed executive totaling 37,199 in 2015 and 36,467 in 2013 were forfeited in 2015. The December 2013 RSUs did not meet the criteria for conversion into shares of common stock pursuant to the applicable performance criteria and, accordingly, remaining awards under this grant were forfeited subsequent to year-end. Recognized in Compensation-related expense are $709,000, $818,000 and $582,000 related to this program during 2016, 2015 and 2014, respectively (excludes amortization associated with awards held by the former CEO subsequent to his resignation). Included in Common stock dividends payable at December 31, 2016 and 2015 are estimated dividends payable pertaining to these awards of $235,000 and $289,000, respectively.

Long-term Equity-based Awards – Stock Awards

Under a performance-based stock award program last utilized in 2012, the Committee granted common stock awards to all employees with staggered three-year vesting periods with vesting subject to the Company generating returns in excess of established return levels. Grants under this program for 118,784, 125,221 and 114,423 shares vested during 2016, 2015 and 2014, respectively. Average grant date fair values for these grants were $12.17, $12.58 and $13.31, respectively. The last awards granted under this program totaling 62,137 shares with a grant date fair value of $11.67 vested in January 2017, together with related deferred dividends.

In January 2017 and February 2016, respectively, the Committee granted service-based stock awards for 74,446 and 67,337 shares of common stock with grant date fair values of $10.41 and $9.32 per share to executives awarded RSUs. In connection with the resignation of the Company’s former CEO, 24,881 shares from the 2016 grant were forfeited subsequent to year-end with the resulting reversal of compensation cost included in Separation of service charge in 2016. Remaining awards and related deferred dividends are scheduled to vest in January 2020 and February 2019, respectively, assuming service conditions are met. In January of 2017 and 2016 and December of 2014 and 2013, respectively, the Committee granted service-based stock awards for 49,416, 61,272, 37,237 and 35,703 shares of common stock with grant date fair values of $10.41, $7.87, $12.47 and $12.34 per share to employees not awarded RSUs. These awards vest in January of 2020, 2019, 2018 and 2017, respectively, assuming service conditions are met.

As a component of the Company’s director compensation program, directors are granted service-based stock awards annually upon election or re-election to the board of directors that vest approximately one year from issuance. In July 2016, director stock awards for a total of 35,000 shares of common stock granted in July 2015 with a grant date fair value of $11.41 per share vested. Also in July 2016, new awards for a total of 41,881 shares with a grant date fair value of $10.03 per share were granted that will vest in July 2017.

Performance-based and service-based stock award activity for the year ended December 31, 2016 is summarized below:

				Weighted
				Average
	Number of			Grant Date
	Shares			Fair Value
Unvested stock awards outstanding at December 31, 2015		288,861		$	11.98
Grants		170,490			8.97
Vestings		(153,784	)		12.00
Unvested stock awards outstanding at December 31, 2016		305,567			10.29

During 2016, 2015 and 2014, the Company recognized in Compensation-related expense $820,000, $878,000 and $1.5 million, respectively, related to amortization of the grant date fair value of employee stock awards (excludes amortization associated with awards held by the former CEO subsequent to his resignation). Included in Common stock dividend payable at December 31, 2016 and 2015 are estimated dividends payable pertaining to these awards totaling $350,000 and $823,000, respectively. In addition, the Company recognized in Other general and administrative expense $409,000, $436,000 and $315,000 related to amortization of the grant date fair value of director stock awards during 2016, 2015 and 2014, respectively. Unrecognized compensation expense for unvested stock awards for all employees and directors other than the former CEO totaled $1.0 million as of December 31, 2016, to be expensed over a weighted average period of 1.4 years (assumes minimal employee and director attrition and any applicable performance metrics would continue to be met for related initial measurement periods).

Service-based stock awards issued to directors and to employees not awarded RSUs receive dividends on a current basis without risk of forfeiture if the related awards do not vest. Stock awards issued to executives awarded RSUs defer the payment of dividends accruing between the grant dates and the end of related performance or service periods. If these awards do not vest, the related accrued dividends will be forfeited.

Long-term Equity-based Awards – Option Awards

At December 31, 2016 option awards for 40,000 shares of common stock were outstanding with a weighted average strike price of $11.86. These awards are currently exercisable, have no aggregate intrinsic value and have a weighted average remaining contractual term of 1.5 years. No option award activity occurred during 2016. All outstanding option awards were granted prior to 2010, have ten-year contractual terms and were issued with strike prices equal to the closing market price of Capstead’s common stock on the dates of grant. The fair value of these awards was estimated at that time using a Black-Scholes option pricing model and was expensed over the related vesting periods.

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 base salary and annual incentive compensation payments. The Company also 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 that have been met by nearly all of Capstead’s current employees. During 2016, 2015 and 2014, the Company recognized in Compensation-related expense $317,000, $391,000 and $258,000 related to contributions to these plans, respectively (excludes nonqualified deferred compensation plan contributions on behalf of the Company’s former CEO subsequent to his resignation). Included in Accounts payable and accrued expenses at December 31, 2016 are $5.6 million in accruals for nonqualified deferred compensation plan balances payable to participating executives (other than the former CEO).