Filing summary
Entity and period: The supplied filing is Five Oaks Investment Corp. (NYSE: OAKS), not Lument Finance Trust, Inc. It is a Form 10-Q for the quarter ended March 31, 2017; the financial statements are unaudited. Investors should verify that this is the intended filing.
Business context and reporting period
Five Oaks is an externally managed mortgage REIT investing primarily in mortgage-backed securities and related assets. Management was shifting the portfolio away from credit-sensitive Non-Agency RMBS and multi-family securities toward Agency RMBS, while winding down prime-jumbo loan aggregation and securitization. The consolidated statements include three securitization trusts; their assets are restricted to trust obligations, which are non-recourse to Five Oaks.
Financial performance and position
- Income: Q1 interest income was $22.19 million and interest expense was $16.41 million, producing net interest income of $5.78 million, versus $5.76 million in Q1 2016. Net income was $2.37 million, compared with a $16.95 million net loss; after preferred dividends, income attributable to common stockholders was $1.49 million, or $0.08 per share, versus a $17.83 million loss, or $1.22 per share. Comprehensive income attributable to common stockholders was $5.04 million.
- Other income and costs: Other income was $0.20 million, versus an $18.27 million loss a year earlier. Q1 2017 included a $9.32 million realized loss on investment sales, a $9.45 million unrealized gain on fair-value-option securities, and a $0.84 million net loss on derivatives. Total expenses declined to $3.62 million from $4.41 million.
- Cash flow: Operating activities used $1.31 million; investing activities used $159.06 million; financing activities provided $162.89 million. Cash, cash equivalents and restricted cash ended at $40.41 million, including $32.71 million of unrestricted cash and $7.69 million of restricted cash.
- Assets, equity and liquidity: Total assets were $2.446 billion and total liabilities $2.301 billion at quarter-end. Stockholders’ equity was $144.87 million, including $37.16 million of preferred equity. Management reported common book value of $6.14 per share, up from $6.00 at year-end. The balance sheet includes $1.322 billion of securitized trust debt that is non-recourse and excluded from management’s leverage discussion.
- Borrowings and leverage: Repurchase-agreement borrowings were $971.23 million, up from $804.81 million at December 31, 2016; the weighted-average rate was 1.06%. Management reported debt-to-equity leverage of 6.7:1, versus 5.6:1 at year-end. Most repo balances mature within 90 days, exposing the company to refinancing and collateral-margin risks. The company reported compliance with financial covenants.
- Distributions: Common dividends declared were $0.15 per share for the quarter, or $0.05 monthly. Preferred dividends were $0.88 million. The board announced a $0.05 monthly common dividend for Q2 2017.
Material changes versus the prior comparable period
- Common results swung from a substantial loss in Q1 2016 to positive earnings in Q1 2017, principally reflecting the reversal in other income/loss and lower expenses; net interest income was nearly unchanged.
- Agency RMBS fair value increased to $999.9 million from $790.2 million at year-end. Management said the additions were primarily Agency hybrid ARMs.
- On management’s non-GAAP combined basis, Non-Agency RMBS exposure fell to $4.9 million from $12.8 million, and Multi-Family MBS exposure fell to $55.5 million from $91.5 million. These measures include net investments in consolidated trusts and are not GAAP balances.
- Book value per common share increased 2.3% during the quarter. Management reported a 4.83% economic gain on common equity, including the $0.14 book-value increase and $0.15 dividend.
Outlook, risks and unusual items
- Management gave no earnings or return guidance. It expected to continue financing investments primarily through repurchase agreements and said current liquidity, borrowing arrangements and cash flows were expected to cover anticipated near-term needs.
- Management estimated approximately $2 million in annual cost savings from reducing prime-jumbo business overhead; substantially all reductions were completed by March 31, 2017. Further savings were expected from business simplification, and management said it would consider reallocating capital to complementary sectors not dependent on short-term repo funding.
- Key risks include interest-rate and spread changes, prepayment and extension risk, credit deterioration, illiquid markets, repo counterparty withdrawal, collateral haircuts and margin calls. The filing’s modeled +100-basis-point rate shock projected a 60.5% decrease in net interest income and a 1.23% decrease in portfolio value; these are scenario estimates, not forecasts.
- FOAC’s MAXEX backstop guarantees covered underlying loans with an aggregate balance of $492.0 million. Management reported no known circumstances expected to trigger payment and no contingent liability recognized; the recorded noncontingent liability was $200,534. The contractual liquidity requirement is the greater of $5 million or 0.10% of covered loan principal.
- The company paid $2.01 million of IRS interest in Q1 related to a 2013 REIT distribution deficiency; $0.15 million of the amount was additional Q1 expense. Management reported no Q1 2017 OTTI loss and no material legal proceedings.
- Controls: Management concluded disclosure controls and procedures were ineffective at March 31, 2017 because of previously identified material weaknesses involving review of REIT tax analysis and accounting for fair-value-option securities. Remediation work was underway, but the new controls were not yet fully operational or deemed remediated.
Most important facts for investors to verify
- Confirm the filing belongs to the intended company: the filing names Five Oaks Investment Corp., while the request identifies Lument Finance Trust, Inc.
- Review the basis and reconciliation of management’s non-GAAP portfolio figures against the GAAP statements, particularly the treatment of consolidated trusts.
- Assess the sustainability of the $0.05 monthly common dividend relative to earnings, REIT distribution requirements, leverage and liquidity needs.
- Monitor short-term repo refinancing, collateral haircuts, margin-call capacity and the concentration of financing counterparties.
- Track remediation and independent testing of the disclosed material weaknesses, and confirm whether management later concluded controls were effective.
- Evaluate the MAXEX guarantee exposure, contractual liquidity requirement and any subsequent claims or changes in covered loan balances.