Filing summary
Entity and period: The supplied filing is Five Oaks Investment Corp.’s Form 10-K for the fiscal year ended December 31, 2016, filed March 16, 2017. It is not identified in the filing as a Lument Finance Trust filing, and it reports annual—not 2016 Q4-only—results. Verify the issuer and filing before relying on this summary.
Business context and strategy
Five Oaks was an externally managed mortgage REIT investing on a leveraged basis in mortgage-backed securities and related assets. During 2016 it shifted toward Agency RMBS, substantially reduced Non-Agency RMBS exposure, and stopped aggregating prime jumbo loans effective August 1. Management cited less attractive economics and tighter, more costly financing for credit assets and loan securitizations. The company expected about $2 million in annualized savings from reducing prime jumbo business costs, with most reductions expected by March 31, 2017.
Financial performance and position
| Metric | FY 2016 | Comparison / context |
|---|---|---|
| Interest income | $93.1 million | Down from $114.4 million in 2015 |
| Interest expense | $69.5 million | Down from $83.1 million |
| Net interest income | $23.6 million | Down from $31.3 million |
| Net income (loss) | $(8.0) million | Versus $0.45 million income in 2015 |
| Net income (loss) attributable to common stockholders | $(11.5) million; $(0.79) per share | Versus $(3.1) million; $(0.21) per share in 2015 |
| Comprehensive loss attributable to common stockholders | $(20.4) million | Included $8.9 million of other comprehensive loss |
| Operating cash flow | $2.3 million | Investing cash outflow was $219.1 million; financing cash inflow was $218.2 million |
| Total assets / stockholders’ equity | $2.300 billion / $142.5 million | Assets include consolidated securitization trusts |
| Common book value per share | $6.00 | Down 37.3% from $9.58 at year-end 2015; share count increased about 20% after the stock portion of the deficiency dividend |
The company also reported a 16.0% economic loss on common equity, comprising a $3.58 decline in net book value per share that exceeded the $2.04 common dividend per share. The $2.04 dividend included a one-time deficiency dividend of approximately $1.33 per share.
Portfolio, financing, and liquidity
- Agency RMBS fair value increased to $790.2 million from $375.3 million at year-end 2015; purchases were primarily hybrid adjustable-rate securities. Non-Agency RMBS fell to $12.8 million on the company’s non-GAAP combined basis from $121.5 million, and Multi-Family MBS fell to $91.5 million on that basis from $190.1 million.
- Repurchase agreements financing available-for-sale securities totaled $804.8 million at year-end, with a 1.07% weighted-average borrowing rate and maturities principally within one year. Reported debt-to-equity leverage was 5.6:1, versus 3.2:1 a year earlier.
- Unrestricted cash was $27.5 million; restricted cash was $10.4 million. The company said it met all financial covenants and promptly met margin calls during 2016. Its weighted-average repo haircut was 6.76%.
- Consolidated trust debt of approximately $1.339 billion was non-recourse and payable only from the trusts’ assets; the company stated its maximum exposure to loss from the three consolidated trusts was $24.7 million.
- Interest-rate sensitivity estimates indicated a 45.99% decline in projected net interest income for an immediate 100-basis-point rate increase and a 44.80% increase for a 100-basis-point decrease. These are model-based estimates, not forecasts.
Material changes, outlook, and risks
- Net interest income declined year over year, primarily reflecting lower principal balances in consolidated securitization trusts. Other losses widened to $16.1 million from $10.1 million, including $7.2 million of realized investment-sale losses, $3.1 million of realized derivative losses, and $4.7 million of losses on fair-value-option securities. Total expenses declined to $14.8 million from $17.1 million; impairment losses declined to $0.7 million from $3.6 million.
- The company completed two Multi-Family MBS re-securitizations or related sales in April 2016, allowing repayment of associated repo financing. It also repaid $49.7 million of FHLB advances and dissolved its captive insurance subsidiary.
- A 2013 REIT tax-position issue led to a $19.4 million deficiency dividend, paid 20% in cash and 80% in newly issued common shares. The company recorded $1.86 million of expected IRS interest expense; it paid $2.01 million in March 2017 and expected to record an additional $0.15 million expense. Management said the tax issue did not misstate prior-period GAAP financial statements.
- Management expected to continue monthly common dividends, but stated distributions were discretionary and not assured. The announced first-quarter 2017 common dividend was $0.05 per share monthly. Preferred stock carried an 8.75% cumulative dividend and priority over common distributions.
- Internal control over financial reporting and disclosure controls were reported ineffective at December 31, 2016 due to material weaknesses, including inadequate technical review of the 2013 REIT tax analysis and earlier accounting-review failures involving fair-value-option securities. Remediation was underway but not complete; the auditor did not attest to internal-control effectiveness.
- Key risks include short-term repo rollover and margin-call exposure, rising funding costs and interest-rate sensitivity, valuation and credit risk, concentrated mortgage collateral, REIT and Investment Company Act compliance, and execution of the business transition. The company also disclosed MAXEX backstop guarantees with a maximum potential payment amount of $469.0 million; no contingent liability was considered probable and reasonably estimable at year-end.
Important facts for investors to verify
- Confirm the issuer: the source names Five Oaks Investment Corp. (ticker OAKS), not Lument Finance Trust.
- Review audited statements and non-GAAP reconciliations, especially the effect of consolidated trusts on reported assets, liabilities, interest income, and leverage.
- Assess the sustainability of net interest income, the higher 5.6:1 leverage, repo maturities and counterparties, and liquidity available for margin calls.
- Track remediation and testing of the disclosed control weaknesses, as well as any further IRS interest or tax consequences.
- Verify realized results from the portfolio shift, projected cost savings, and the level and funding of future common and preferred dividends.