Business context and reporting period
Five Oaks Investment Corp. (NYSE: OAKS), an externally managed REIT investing in mortgage-backed securities, residential mortgage loans and related assets, filed this unaudited Form 10-Q for the quarter ended September 30, 2015. The filing names Five Oaks, not Lument Finance Trust; the company identity in the request metadata therefore does not match the filing.
Management described a transition toward a credit-focused operating business, including loan aggregation and securitization. Comparisons with 2014 require caution: consolidation of four securitization trusts and adoption of ASU 2014-11 changed the presentation of assets, debt and results.
Financial results and position
| Metric | Q3 2015 / September 30, 2015 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $27.52 million | $8.27 million in Q3 2014 |
| Net interest income | $7.17 million | $4.67 million in Q3 2014 |
| Net income (loss) | $(1.31) million; common-stockholder loss $(2.19) million, or $(0.15) per share | Q3 2014 net income $5.03 million; common-stockholder income $4.15 million, or $0.28 per share |
| Nine-month net income (loss) | $(2.40) million; common-stockholder loss $(5.03) million, or $(0.34) per share | Nine months 2014 net income $6.92 million; common-stockholder income $4.92 million, or $0.43 per share |
| Total assets / stockholders’ equity | $2.581 billion / $188.3 million | $2.922 billion / $212.8 million at December 31, 2014 |
| Common book value per share | $10.26 | $10.71 at June 30, 2015 |
| Cash and cash flows | Cash $27.5 million; nine-month operating cash flow $2.84 million, investing inflow $237.3 million and financing outflow $245.0 million | Cash was $32.3 million at December 31, 2014 |
| Borrowings | Repurchase agreements: $466.3 million; FHLB advances: $51.4 million | Repurchase agreements: $594.9 million at December 31, 2014; no FHLB advances then |
Q3 total expenses were $3.50 million. For the nine months, impairment charges were $4.65 million, versus none in 2014. The company reported $10.89 million of other losses for the nine months, including $12.31 million of realized derivative losses. Nine-month net interest income increased to $24.89 million from $11.91 million, but these periods are not directly comparable because trust income and expenses are consolidated in 2015.
At September 30, $1.871 billion of securitized debt related to consolidated trusts was non-recourse to Five Oaks and supported by restricted trust assets. The company reported $27.5 million of unrestricted cash and $11.5 million of restricted cash. Its repurchase agreements were short-term, with a 1.47% weighted-average rate and 45-day weighted-average maturity; the company reported covenant compliance.
Material changes versus prior periods
- Management said the MBS portfolio was reduced 13.3% during Q3, primarily through sales of Non-Agency RMBS, in response to interest-rate and credit-market volatility. Non-GAAP combined MBS fair value fell from $689.9 million at June 30 to $598.1 million at September 30.
- Common book value declined 4.2% quarter over quarter, from $10.71 to $10.26 per share. Management cited credit-spread widening and derivative value changes. Its reported economic loss on common equity was 1.4% for the quarter after the $0.30 common dividend.
- Common dividends were $0.30 per share in Q3, compared with $0.38 in Q3 2014; nine-month dividends were $1.05 versus $1.10.
- ASU 2014-11 brought certain formerly net-presented linked transactions onto the balance sheet as securities and repurchase debt. The filing cautions that reported GAAP balances and results are not directly comparable with prior periods.
- FOI, the company’s insurance subsidiary, became an FHLB Indianapolis member and had $51.4 million of advances outstanding at quarter-end.
Outlook, risks and unusual items
- Management announced monthly common dividends of $0.10 per share for Q4 2015 and said it intended to continue regular monthly distributions, subject to available cash, operating needs and debt service.
- Management said it had priced a second proprietary prime-jumbo securitization on November 5, 2015, scheduled to settle November 10. It expected to retain B-notes, interest-only securities and excess servicing rights. This was a subsequent event, not a Q3 completed transaction.
- Management expected available cash, operating cash flow and borrowing capacity to cover anticipated short-term liquidity needs, but said longer-term liquidity depends on continued access to debt and equity financing. FHLB borrowing capacity of up to $500 million was uncommitted, subject to FHLB discretion, collateral and approval; approval to use it for prime-jumbo loan funding had not been obtained.
- Key exposures include interest-rate and spread volatility, credit losses, prepayment and extension risk, short-term repo funding, margin calls and counterparty renewal risk. The company said it met margin calls during the period. Its modeled sensitivity estimated that a 100-basis-point rate increase would reduce projected net interest income by 19.52%; these estimates depend on assumptions and are not forecasts.
- All current derivatives were accounted for as trading instruments rather than hedge-accounting instruments, contributing to earnings volatility. During Q3, the company replaced interest-rate swaps with Eurodollar futures, citing liquidity and lower margin requirements.
- The company recorded a $0.35 million Q3 credit-reserve increase and $4.65 million of impairment charges for the nine months, reflecting revised credit-loss expectations on certain legacy Non-Agency RMBS. No material legal proceedings or material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Confirm the filing identity: this document is for Five Oaks Investment Corp., not Lument Finance Trust.
- Review the non-GAAP portfolio reconciliation and trust consolidations when comparing periods; consolidated trust assets and debt are restricted and non-recourse, but materially enlarge reported GAAP totals.
- Track common book value, dividend coverage, and the effect of derivative and credit marks on earnings and equity.
- Verify repo maturities, collateral haircuts, margin-call requirements and access to replacement financing; most repo obligations mature within one year.
- Check the settlement and retained exposures from the November 2015 securitization, and whether FHLB financing for loan acquisitions was approved.