Lument Finance Trust, Inc. quarterly report, Q3 FY2017

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Filing identity and reporting period

The supplied filing is Five Oaks Investment Corp.’s unaudited Form 10-Q for the quarter ended September 30, 2017—not a filing under the name Lument Finance Trust, Inc. Investors should verify the entity and any relationship to Lument before relying on this summary.

Five Oaks was an externally managed mortgage REIT investing primarily in mortgage-backed securities (MBS), mortgage servicing rights and other mortgage-related assets. It was shifting away from credit-sensitive holdings and residential loan aggregation toward Agency MBS, particularly hybrid adjustable-rate securities.

Financial performance and position

  • Third-quarter results: Interest income was $22.6 million and interest expense was $17.9 million, producing net interest income of $4.7 million, down from $6.2 million a year earlier. Net loss was $4.3 million; after preferred dividends, the loss attributable to common stockholders was $5.1 million, or $0.23 per share. The comparable 2016 quarter generated $0.04 per share.
  • Nine-month results: Net interest income was $15.4 million versus $17.7 million in 2016. Loss attributable to common stockholders was $6.8 million, or $0.35 per share, compared with a $22.2 million loss, or $1.52 per share, in the prior-year period. The improvement primarily reflected less adverse other income/loss and lower expenses.
  • Other income and unusual items: Third-quarter other loss was $5.9 million, including $5.1 million of realized investment-sale losses and $1.6 million of realized derivative losses. For the first nine months, other loss was $9.7 million, including $14.6 million of realized investment-sale losses and $8.6 million of unrealized derivative losses; these were partly offset by fair-value gains. No OTTI losses were recognized in 2017.
  • Assets, debt and equity: Total assets were $2.64 billion and total liabilities $2.49 billion at quarter-end. Stockholders’ equity was $150.5 million, including $113.3 million of common equity and $37.2 million of preferred equity. Book value per common share was $5.12, down from $5.41 at June 30. Management reported a 2.59% quarterly economic loss on common equity, including the $0.29 book-value decline and $0.15 common dividend.
  • Liquidity and leverage: Cash and cash equivalents were $30.6 million, with another $15.4 million restricted as collateral. Repurchase borrowings were $1.238 billion at a weighted-average rate of 1.37%; weighted average maturity was 14 days and most borrowings matured within 30 days. Reported debt-to-equity leverage was 8.2:1, up from 7.3:1 at June 30. Separately, $1.249 billion of securitized obligations were non-recourse trust liabilities, excluded from management’s leverage measure.
  • Cash flow, nine months: Operating cash flow was $0.9 million; investing cash flow was negative $434.3 million; financing cash flow was positive $441.5 million. Cash, cash equivalents and restricted cash increased by $8.1 million to $46.0 million.
  • Dividends and capital: Common dividends declared totaled $0.45 per share for the first nine months. The company announced a fourth-quarter 2017 common dividend rate of $0.05 per share monthly. A June 2017 common-stock offering raised estimated net proceeds of $19.8 million.

Material changes versus comparable periods

  • Third-quarter net interest income declined year over year as financing costs rose and balances in consolidated securitization trusts declined. Repo interest expense on the larger Agency portfolio increased.
  • Management sold $416.0 million of seasoned, shorter-duration Agency ARMs and acquired $513.6 million of new-issue, longer-duration Agency ARMs. It reported that Agency portfolio yield rose to 2.47% from 2.34% at the prior quarter-end.
  • Available-for-sale securities increased to $1.304 billion from $870.9 million at year-end 2016, reflecting the greater Agency RMBS focus. Common shares outstanding rose to 22.1 million from 17.5 million at year-end, principally following the equity issuance.
  • Management said the reduction of prime-jumbo loan business overhead was substantially complete and estimated annual savings of $2 million. Manager expense reimbursements were also capped at $2 million for specified non-investment-management professional compensation expenses during the 12 months beginning October 1, 2017, unless the board agreed otherwise.

Outlook, risks and contingencies

  • Management stated that available cash, operating cash flow and borrowing capacity were expected to cover anticipated short-term liquidity needs under the then-current portfolio and financing arrangements. This is not a guarantee; the filing provides no earnings guidance.
  • Key risks include rising short-term rates compressing net interest spread, spread widening and fair-value losses, prepayment or extension risk, derivative mismatch, credit deterioration, repo counterparty non-renewal and collateral margin calls. The company reported that it met margin calls during the period and complied with financing covenants at September 30.
  • The MAXEX seller-backstop guarantees covered underlying loans with an aggregate balance of up to $548.8 million. The company reported no known circumstances expected to trigger a guarantee payment and recorded no contingent liability; the $202,896 deferred-income balance represented the unamortized guarantee fees. The guarantee terms also required minimum available liquidity based on a stated formula.
  • Disclosure controls and procedures were deemed ineffective because of material weaknesses in internal controls, including review deficiencies involving REIT tax analysis and consolidated trust balances. A third-quarter trust balance discrepancy required an adjustment to asset and liability balances but did not affect equity or net income. Remediation work was ongoing, and management said the weaknesses would not be considered remediated until controls had operated and been tested effectively.
  • The company paid $2.01 million of IRS interest in March 2017 related to a prior-year REIT deficiency dividend; $0.15 million above the amount previously provisioned was expensed in first-quarter 2017. No material legal proceedings or subsequent events requiring disclosure were reported.

Important facts for investors to verify

  1. Confirm that Five Oaks Investment Corp. is the intended filing entity and establish any connection to Lument Finance Trust.
  2. Review the sustainability of net interest income as repo funding costs, leverage and short-term refinancing needs change.
  3. Assess the Agency hybrid-ARM rotation, portfolio yields, book-value movement and realized investment and hedge losses.
  4. Verify common and preferred dividend terms and the company’s capacity to fund distributions while meeting REIT requirements.
  5. Monitor MAXEX guarantee exposure, liquidity requirements and any developments in the disclosed internal-control weaknesses.