Lument Finance Trust, Inc. quarterly report, Q2 FY2016

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Business context and reporting period

The supplied filing is Five Oaks Investment Corp. and subsidiaries’ unaudited Form 10-Q for the quarter ended June 30, 2016—not a filing under the name Lument Finance Trust, Inc. Confirm the issuer before relying on this summary. Five Oaks was an externally managed mortgage REIT investing in mortgage-backed securities, residential mortgage loans and mortgage servicing rights.

Financial performance and position

  • Second quarter: Net interest income was $5.77 million, down from $8.57 million in Q2 2015. Net loss was $4.08 million; loss attributable to common stockholders was $4.95 million, or $0.34 per share, versus income attributable to common stockholders of $2.93 million, or $0.20 per share, a year earlier. Comprehensive loss attributable to common stockholders was $0.85 million.
  • First half: Net interest income was $11.53 million, versus $17.67 million in 2015. Net loss attributable to common stockholders was $22.78 million, or $1.56 per share, compared with a $3.08 million loss, or $0.21 per share, in the prior-year period. Comprehensive loss attributable to common stockholders was $19.78 million.
  • Drivers and margins: First-half interest income was $48.23 million and interest expense was $36.69 million. Other losses totaled $24.11 million, including $10.51 million of unrealized derivative losses, $2.35 million of realized derivative losses and $6.54 million of unrealized losses on consolidated multifamily loans. The filing reports a 3.12% weighted-average portfolio yield on a GAAP basis; it does not provide a clear net interest margin figure.
  • Balance sheet and liquidity: At June 30, total assets were $2.30 billion, total liabilities $2.15 billion and stockholders’ equity $152.20 million, including $115.04 million of common equity. Cash and cash equivalents were $25.54 million; restricted cash was $14.45 million. First-half operating cash flow was negative $0.94 million, investing cash flow negative $111.53 million and financing cash flow positive $111.87 million; cash declined $0.60 million.
  • Debt and leverage: Repurchase-agreement borrowings, including financing for held-for-sale loans, totaled $687.60 million and carried a 0.92% weighted-average rate. Overall debt-to-equity leverage was 4.5:1, compared with 3.0:1 at March 31, 2016. Consolidated securitization-trust obligations of approximately $1.45 billion were described as nonrecourse to Five Oaks and are distinct from its corporate borrowings.
  • Book value and distributions: Book value per common share was $7.88, down 3.0% from $8.12 at the prior quarter-end. Common dividends declared were $0.18 per share for Q2 and $0.36 for the first half; the company announced Q3 monthly dividends of $0.06 per share.

Material changes versus comparable periods

  • Net interest income declined year over year in both Q2 and the first half, principally reflecting lower principal balances in consolidated securitization trusts, portfolio changes and reduced exposure to credit-sensitive investments.
  • Five Oaks reported a Q2 common-equity economic loss of 0.7%: the $0.24 decline in book value per share exceeded the $0.18 common dividend. Management attributed the book-value decline chiefly to the two April multifamily re-securitizations.
  • The portfolio shifted toward Agency RMBS. From March 31 to June 30, Agency RMBS increased from $324.8 million to $619.8 million; Non-Agency RMBS declined from $84.4 million to $57.4 million on the company’s combined non-GAAP basis, and multifamily MBS declined from $173.8 million to $107.6 million on that basis.
  • In Q2 the company sold first-loss and subordinated securities in the JPMMT 2014-OAK4 trust and ceased consolidating it. It completed two multifamily Re-REMIC transactions, which repaid related repo financing and replaced it with term financing for portions of the positions.

Outlook, risks and unusual items

  • Effective August 1, 2016, Five Oaks stopped aggregating prime-jumbo mortgage loans and said it would securitize through its platform only opportunistically. It did not intend to maintain warehouse financing for loan acquisitions. Management estimated annual cost savings of $2 million over the next 6–12 months from reducing personnel and overhead, and said it would consider reallocating capital to complementary businesses not reliant on short-term repo financing.
  • Management cited constrained financing availability for credit-sensitive assets, market volatility and reduced liquidity, interest-rate and spread movements, prepayment and extension risk, credit losses, and potential repo margin calls. It said Q2 margin calls were met promptly and that the company was in compliance with its financial covenants at June 30.
  • Re-REMIC transactions reduced short-term repo exposure and potential margin-call risk, but management said their one-time economic impact reduced book value and the associated trust fair-value losses exceeded realized gains from securities sold into the transactions.
  • Interest-rate sensitivity estimates showed projected net interest income falling 69.71% for an immediate +1.00% rate shock and rising 50.68% for a −1.00% shock; projected portfolio value changes were −0.17% and −0.24%, respectively. These are model-based estimates, not forecasts, and depend on stated assumptions.
  • Disclosure controls and procedures were reported ineffective at June 30 because of a material weakness in timely review of accounting treatment. The weakness had led to corrections and restatements of 2015 interim financial statements. Remediation work was underway, but the new systems and controls were not yet fully operational and management could not estimate when remediation would be complete.
  • No material legal proceedings were reported. The company said it believed it would maintain REIT qualification, while noting that qualification depends on meeting ongoing requirements.

Important facts for investors to verify

  1. Confirm that Five Oaks Investment Corp.—rather than Lument Finance Trust, Inc.—is the intended issuer and filing.
  2. Review the reported Q2 and first-half losses against the large fair-value and derivative effects, and distinguish GAAP results from management’s non-GAAP portfolio measures.
  3. Assess whether the $2 million projected annual cost savings are achieved and whether the prime-jumbo business changes affect servicing income, MSRs or future capital deployment.
  4. Monitor repo renewal, counterparty concentration, collateral haircuts, margin-call liquidity and the company’s 4.5:1 leverage.
  5. Track book value, dividend coverage and the sustainability of the stated monthly common dividend, particularly given the first-half loss and REIT distribution requirements.
  6. Confirm completion and effectiveness of the disclosed internal-control remediation; controls remained ineffective at quarter-end.