Lument Finance Trust, Inc. quarterly report, Q2 FY2017

Full document

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, 2017. The request metadata names Lument Finance Trust, Inc., but the filing itself identifies the registrant as Five Oaks Investment Corp. (NYSE: OAKS); confirm the intended issuer before relying on this summary.

Five Oaks was an externally managed mortgage REIT investing in mortgage-backed securities and related assets. During the quarter it continued shifting its portfolio away from credit-sensitive assets and toward Agency mortgage-backed securities, particularly hybrid adjustable-rate securities, while winding down its residential loan aggregation business.

Financial Results and Position

  • Second-quarter results: Net loss was $2.30 million; loss attributable to common stockholders was $3.17 million, or $0.17 per share, versus a $4.95 million common-stockholder loss, or $0.34 per share, in Q2 2016.
  • First-half results: Net income was $0.07 million, but after preferred dividends the common-stockholder loss was $1.68 million, or $0.09 per share. In first-half 2016, the common-stockholder loss was $22.78 million, or $1.56 per share.
  • Net interest income: $4.83 million in Q2 2017 versus $5.77 million in Q2 2016; $10.61 million in the first half versus $11.53 million. Management attributed the decline to higher financing costs and lower principal balances in consolidated securitization trusts.
  • Other income and valuation effects: Other loss was $3.99 million in Q2 and $3.79 million for the first half. First-half realized investment-sale losses were $9.47 million, and unrealized derivative losses were $8.89 million; these were partly offset by $9.45 million in unrealized gains on fair-value-option securities. No OTTI losses were recognized in the first half of 2017.
  • Expenses: Total expenses were $3.14 million in Q2 and $6.75 million in the first half, down from $3.86 million and $8.28 million, respectively, in 2016. The filing attributes the decrease mainly to eliminating costs associated with the prime-jumbo mortgage business.
  • Assets and equity: Total assets were $2.63 billion at June 30, 2017, including assets of consolidated trusts. Stockholders’ equity was $156.9 million, including $37.2 million of preferred equity; common book value was $5.41 per share, down from $6.14 at March 31. Management reported a 9.45% second-quarter economic loss on common equity, including a $0.73 decline in book value per share and the $0.15 common dividend.
  • Portfolio and financing: Agency RMBS fair value rose to $1.22 billion from $790.2 million at year-end 2016. Total repurchase-agreement borrowings were $1.15 billion, at a 1.34% weighted-average rate; reported debt-to-equity was 7.3:1. The three consolidated securitization trusts had $1.28 billion of non-recourse liabilities, which the company excluded from its leverage discussion; trust assets are restricted to their obligations.
  • Liquidity and cash flow: Cash and cash equivalents were $41.4 million, with another $15.8 million restricted as collateral. First-half operating cash flow was negative $0.86 million; investing cash outflow was $334.5 million and financing cash inflow was $354.7 million. The company said available liquidity and borrowing capacity were expected to cover anticipated short-term needs.
  • Capital and distributions: The June common-stock offering issued 4.6 million shares at $4.60 each, generating estimated net proceeds of $19.8 million. Common dividends declared were $0.30 per share for the first half; Series A preferred stock carries an 8.75% annual dividend rate.

Material Changes, Outlook, and Risks

  • The June equity issuance funded additional Agency RMBS purchases and increased stockholders’ equity, but issuance below book value contributed to per-share dilution. Management cited widening Agency hybrid ARM spreads as producing unrealized portfolio losses during the quarter.
  • Management said it intended to continue regular monthly common dividends and announced a third-quarter 2017 rate of $0.05 per share per month. Distributions remain subject to earnings, liquidity, financing obligations, and REIT requirements; this is not a guarantee of future dividends.
  • Interest-rate sensitivity analysis estimated that an immediate 100-basis-point increase would reduce projected net interest income by 74.33% and portfolio value by 1.11%; a 100-basis-point decrease was estimated to increase projected net interest income by 74.33% and reduce portfolio value by 0.37%. These are model-based estimates with stated assumptions, not forecasts.
  • Key risks include short-term repo financing of longer-lived assets, collateral haircuts and margin calls, interest-rate and spread movements, prepayment and extension risk, credit and real-estate exposure, and potential changes to U.S. housing finance policy. The company reported that it met margin calls during the period and was in compliance with its financial covenants at June 30.
  • Through FOAC, the company provided seller-eligibility and backstop services to MAXEX. Maximum potential payments under outstanding backstop guarantees were estimated at $493.3 million, although the company said it knew of no circumstances expected to trigger an obligation and recognized no contingent liability. FOAC had a minimum available-liquidity requirement under the arrangement.
  • Management reported disclosure controls were not effective at June 30 because of previously identified material weaknesses involving REIT tax technical review and financial reporting controls. Remediation work was underway, but controls were not yet fully operational or considered remediated.
  • Subsequent to quarter-end, Oak Circle committed to cap reimbursements for specified non-investment-management professional compensation expenses at $2.0 million for the 12 months beginning October 1, 2017, unless the board agrees otherwise.

Most Important Facts to Verify

  1. Confirm the issuer: the supplied filing is for Five Oaks Investment Corp., not an entity named Lument Finance Trust, Inc.
  2. Review the full filing’s portfolio valuation, repo counterparties, collateral haircuts, margin-call exposure, and borrowing maturities; most repo debt was short term.
  3. Assess the sustainability of the common dividend against taxable income, cash generation, financing needs, and preferred-dividend priority.
  4. Examine the $493.3 million maximum backstop-guarantee exposure, its recovery arrangements, liquidity requirement, and any subsequent developments.
  5. Track remediation and testing of the disclosed material weaknesses in internal controls and disclosure controls.
  6. Distinguish reported GAAP balances from management’s non-GAAP portfolio and leverage presentations, including the treatment of consolidated non-recourse trusts.