Filing summary
Entity and period: The supplied filing is Five Oaks Investment Corp. (NYSE: OAKS), not Lument Finance Trust, Inc. It is an unaudited Form 10-Q for the quarter ended September 30, 2014, filed November 14, 2014. Five Oaks invested in mortgage-backed securities and residential mortgage loans and elected REIT tax treatment.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net interest income | $4.67 million | $3.55 million | $11.91 million | $10.81 million |
| Net income (loss) | $5.03 million | ($17.01 million) | $6.92 million | ($7.52 million) |
| Income (loss) attributable to common stockholders | $4.15 million | ($17.01 million) | $4.92 million | ($7.52 million) |
| Basic and diluted EPS | $0.28 | ($2.31) | $0.43 | ($1.32) |
| Common dividends declared per share | $0.38 | $0.48 | $1.10 | $1.28 |
For the nine months, interest income was $16.67 million and interest expense, including derivative payments, was $7.17 million. Other income was $1.94 million, versus a $14.95 million loss in 2013. Results included substantial derivative gains and losses and fair-value movements; available-for-sale security unrealized gains and losses generally flowed through other comprehensive income rather than earnings. The filing reports nine-month comprehensive income attributable to common stockholders of $21.44 million.
Balance sheet, cash flow and financing
- Total assets were $2.24 billion and stockholders’ equity was $221.1 million at September 30, 2014, compared with $528.2 million and $113.9 million, respectively, at December 31, 2013. The large asset increase principally reflects first-time consolidation of a multifamily securitization trust.
- Cash and cash equivalents were $21.1 million; restricted cash was $37.1 million. Nine-month operating cash flow was $12.0 million, investing cash flow was negative $363.2 million, and financing cash flow was positive $339.2 million.
- Reported repurchase-agreement borrowings were $499.5 million for available-for-sale securities and $205.2 million for mortgage loans. Including financing underlying linked transactions, securities-related repo borrowings were $685.7 million. The stated weighted-average rate on reported repo agreements was 1.14%; mortgage-loan warehouse borrowings carried a 2.55% weighted-average rate.
- Leverage was 3.2 times GAAP stockholders’ equity, or 4.0 times including linked-transaction financing. The consolidated trust added $1.31 billion of securitized debt, but this debt is non-recourse to Five Oaks and is excluded from its leverage discussion.
- Unrestricted cash and unpledged securities available for margin needs were approximately $21.8 million at quarter-end, down from $55.8 million at June 30. The company reported that it met margin calls during the period and was in compliance with repo covenants.
Material changes and outlook
- Five Oaks acquired an 85% first-loss principal-only tranche and related interest-only security in the Freddie Mac-sponsored FREMF 2011-K13 Trust for approximately $55.5 million, and consolidated the trust. Its reported net carrying value was $55.8 million; the trust’s assets are restricted to its obligations.
- The company expanded into residential mortgage loans: quarter-end loans held for sale were $227.0 million, financed with $205.2 million of warehouse borrowings. It completed its first prime-jumbo securitization in October 2014 and expected to consolidate that trust; it also purchased another multifamily equity tranche for approximately $22.9 million in October.
- Management reported a 0.9% economic return on common equity for Q3, or 3.6% annualized, combining a $0.38 dividend with a $0.26 decline in book value per share. Quarter-end book value was $12.50 per common share, down from $12.76 at the prior quarter-end.
- Management expected overall leverage to range from three to six times equity, depending on asset mix. It stated that current capital, operating cash flow and borrowing capacity should cover anticipated short-term needs, while long-term liquidity depends on access to debt and equity financing. The company announced Q4 2014 common dividends of $0.125 per share monthly; this is a stated distribution plan, not earnings guidance.
- Key risks include short-term repo financing and margin calls, interest-rate and prepayment exposure, credit losses, counterparty and refinancing risk, and fair-value volatility. The company cautioned that derivative hedges may not offset exposures and that it does not apply hedge accounting to its derivative portfolio.
- Management said adoption of ASU 2014-11 would materially change presentation of linked transactions when effective. It also warned that future VIE consolidation and fair-value accounting could increase earnings volatility. The filing reports no material legal proceedings and says disclosure controls were effective.
Most important facts to verify
- Confirm that Five Oaks—not Lument Finance Trust—is the intended issuer and that 2014 Q3 is the intended filing period.
- Review the distinction between GAAP and non-GAAP portfolio and borrowing figures, particularly linked transactions and the non-recourse consolidated trust.
- Assess liquidity against short-term repo maturities, collateral haircuts, margin-call exposure and the decline in available liquidity.
- Examine the drivers and sustainability of reported earnings, including derivative results, fair-value estimates and the effect of the 2014 acquisitions and offerings.
- Verify the execution, consolidation and profitability of the October 2014 securitization and subsequent multifamily investment, as well as the stated monthly dividend plan.