Lument Finance Trust, Inc. quarterly report, Q2 FY2014

Business context and reporting period

This is Five Oaks Investment Corp.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2014 (ticker OAKS), not a filing under the name Lument Finance Trust, Inc. Five Oaks was an externally managed mortgage REIT investing in Agency and Non-Agency residential mortgage-backed securities (RMBS), multifamily securities and, beginning this quarter, prime jumbo residential mortgage loans.

Financial results and position

Metric	Q2 2014	Q2 2013	Six months 2014	Six months 2013
Net interest income	$3.89 million	$6.36 million	$7.24 million	$7.26 million
Net income	$4.42 million	$7.97 million	$1.88 million	$9.50 million
Net income attributable to common stockholders	$3.79 million	$7.97 million	$0.77 million	$9.50 million
Basic and diluted EPS	$0.34	$1.08	$0.08	$1.96

Q2 total other income was $2.84 million, including $8.81 million of gains and net interest income from linked transactions, partly offset by $6.82 million of derivative losses. For the first half, other income was a $1.45 million loss, versus $4.15 million income in 2013.
Six-month operating cash flow was $7.05 million; investing cash flow was negative $130.95 million and financing cash flow was positive $146.66 million. Cash and cash equivalents ended the period at $55.81 million.
At June 30, total assets were $758.20 million, total liabilities $539.92 million and stockholders’ equity $218.28 million. Available-for-sale securities were $570.76 million; mortgage loans held for sale were $4.51 million.
Repurchase-agreement borrowings were $512.29 million, including $3.96 million for the loan warehouse facility. The company reported $508.33 million of securities-related repos on a GAAP basis and $706.05 million including linked-transaction financing on a non-GAAP basis. GAAP and non-GAAP leverage were 2.3x and 3.3x equity, respectively.
Unrestricted cash was $55.8 million and restricted cash was $43.4 million. The weighted-average rate on GAAP repos was 0.51%; the broader non-GAAP borrowing rate, including linked transactions, was reported as 0.83% in the liquidity discussion.
Book value per common share was $12.76, down 0.6% from $12.84 at March 31. Comprehensive income attributable to common stockholders was $9.41 million for Q2 and $18.80 million for the first half, largely reflecting unrealized securities gains recorded in other comprehensive income.

Material changes versus comparable periods

Q2 common earnings and EPS fell year over year, primarily as net interest income declined and the prior-year quarter included materially different gains from derivatives and investment sales. First-half common earnings also fell sharply, reflecting a $1.45 million net other loss, higher expenses and preferred dividends; the company cautioned that comparison is affected by its March 2013 IPO.
Mortgage-backed securities increased to $570.8 million from $445.0 million at year-end 2013. Agency RMBS grew to $501.0 million; the company also began buying prime jumbo loans and expanded into multifamily MBS.
Q2 equity issuances brought in approximately $38.4 million net from common stock and $16.3 million net from Series A preferred stock. Common shares outstanding rose to 14.19 million at June 30 from 7.39 million at year-end 2013; 14.71 million were outstanding August 14.
Total expenses for the first half rose to $3.90 million from $1.92 million. Management cited higher average equity and increased operating activity as factors.

Outlook, risks and unusual items

Management said it expected increased mortgage-loan activity in Q3 as correspondent relationships and loan-purchase commitments developed. It reported $4.5 million of loans at quarter-end. Subsequent to quarter-end, FOAC entered two facilities with aggregate capacity of $200 million; it had borrowed $151.2 million against loans with $162.5 million unpaid principal by August 11. Five Oaks guaranteed these facilities.
Management’s leverage framework was generally 3x–6x equity overall, with asset-class targets varying; it expected 6x–9x for Agency RMBS and residential loans. The filing stated these are expectations, not fixed limits.
The board announced monthly common dividends of $0.125 per share for Q3 2014. The company intends regular monthly distributions, subject to operating needs, debt service and REIT requirements.
Interest-rate sensitivity estimates projected that an immediate 100-basis-point rise would reduce annualized net interest income by 15.83%, while a 100-basis-point fall would increase it by 19.87%; these are model-based estimates, not forecasts. Management warned that hedges may not fully offset rate, prepayment or funding risks.
Liquidity risks include short-term repo funding against longer-lived assets, collateral haircuts and margin calls. Haircuts ranged from 3% to 40% (12.8% weighted average); the company said it met all margin calls during the period. Rising rates, falling collateral values, counterparty funding changes, prepayments and credit deterioration could pressure results or liquidity.
Non-Agency RMBS had 27.8% 60-or-more-day delinquencies, 2.8% average remaining credit enhancement and substantial unrated exposure (57.4% by fair value). These assets, as well as non-guaranteed multifamily securities and the new loan portfolio, carry credit risk.
ASU 2014-11, effective for the company in 2015, was expected to materially change presentation of linked transactions, including gross presentation of related securities and repos and changes in where some income and fair-value movements are reported.
The company said disclosure controls were effective, no material internal-control changes occurred, no material legal proceedings were identified, and there were no material changes to previously disclosed risk factors.

Important facts for investors to verify

Reconcile GAAP and non-GAAP portfolio, borrowing and leverage figures, particularly the $197.7 million of repos underlying linked transactions.
Review the sustainability of common dividends against taxable income, cash generation, preferred dividends and refinancing or margin-call needs.
Track the performance and funding of the new jumbo-loan business, including the post-quarter facilities, guarantees and securitization plans.
Assess derivative losses, the effectiveness and maturity matching of hedges, and sensitivity to interest rates and prepayment speeds.
Monitor Non-Agency RMBS delinquency, credit-enhancement and rating data, as well as multifamily and loan credit performance.
Confirm the effect of the 2015 linked-transaction accounting change and the comparability of reported results after adoption.