Business context and reporting period
This is Five Oaks Investment Corp.’s unaudited Form 10-Q for the quarter ended June 30, 2013—not a filing identified as Lument Finance Trust, Inc. Five Oaks, an externally managed mortgage REIT, invests primarily in Agency and Non-Agency residential mortgage-backed securities (RMBS) and finances holdings largely with repurchase agreements. It began operations in May 2012 and became publicly traded in March 2013; consequently, the short 2012 startup-period comparison is not directly comparable.
Financial performance and position
- Second-quarter results: Interest income was $7.36 million, interest expense $1.00 million, and net interest income $6.36 million. Net income attributable to common stockholders was $7.97 million, or $1.08 per share.
- First half: Interest income was $10.59 million, net interest income $7.26 million, and net income $9.50 million, or $1.96 per share. Other income of $4.15 million included $11.07 million of realized derivative gains and $7.10 million of unrealized derivative gains, partly offset by $14.28 million of realized investment-sale losses.
- Comprehensive loss: First-half comprehensive loss attributable to common stockholders was $16.94 million, largely reflecting $26.44 million of unrealized AFS securities losses recorded in other comprehensive income. AFS securities’ fair value was $590.30 million, versus amortized cost of $614.30 million.
- Balance sheet and leverage: At June 30, total assets were $659.70 million, total liabilities $564.18 million, and stockholders’ equity $95.51 million. Repurchase-agreement debt was $563.53 million on a GAAP basis; leverage was 5.9 times equity (6.2 times including financing associated with Linked Transactions, a non-GAAP measure). The weighted-average repo rate was 0.48%.
- Liquidity and cash flow: Cash and cash equivalents were $20.89 million, with a further $23.63 million restricted as collateral. First-half operating cash flow was $4.86 million; investing cash flow was negative $560.90 million and financing cash flow positive $573.32 million. Management reported that margin calls during the period were met promptly.
- Portfolio and shareholder returns: GAAP AFS holdings comprised $557.65 million of Agency RMBS and $32.66 million of Non-Agency RMBS. Including Non-Agency RMBS underlying Linked Transactions, the portfolio’s non-GAAP fair value was approximately $636.3 million. First-half common dividends declared totaled $0.78 per share. The company announced a $0.16-per-share monthly dividend rate for the third quarter.
- Book value: Book value was $12.93 per share at June 30, down 18.1% from $15.77 at March 31, primarily due to higher long-term rates and wider RMBS spreads.
Changes, outlook, risks, and unusual items
- After the March IPO and concurrent private placement, the company initially increased Agency RMBS holdings. In the second quarter, amid rising rates and volatility, it sold Agency positions, selectively increased Non-Agency exposure, and reduced GAAP RMBS holdings to $590.3 million from $969.0 million at March 31. GAAP repo borrowings fell to $563.5 million from $920.4 million.
- Management said heightened market volatility—following Federal Reserve discussion of potentially reducing asset purchases—affected investment and financing decisions and could prompt more frequent strategy adjustments. The filing provides no specific earnings guidance.
- Management expected overall leverage generally to range from three to six times equity, depending on portfolio mix, and said it intended to continue regular monthly distributions. It believed equity proceeds, operating cash flow, and borrowing capacity would cover anticipated short-term needs; longer-term funding depends on access to debt and equity markets.
- Interest-rate, spread, prepayment, credit, and repo-renewal risks are material. The company’s modeled 12-month sensitivity for a parallel 100-basis-point rate increase showed projected net interest income down 16.42% and Agency portfolio value down 1.78%; these are estimates, not forecasts. The company also disclosed margin-call exposure and that repo lenders may demand more collateral or decline to renew funding.
- Non-Agency credit exposure included 27.8% 60-plus-day delinquencies and only 0.2% average remaining credit enhancement on the reported combined portfolio. A majority of that portfolio was not rated, and 37.0% of its fair value was concentrated in California.
- Five Oaks formed a wholly owned taxable REIT subsidiary in June to pursue residential mortgage loan acquisition and disposition; it had no second-quarter activity. The company also reported considering a subordinated debt investment in a Freddie Mac multifamily securitization.
- Controls: Management disclosed an unresolved material weakness involving accounting for certain Non-Agency RMBS and related repo financings as “Linked Transactions,” plus a significant deficiency concerning review of service-organization controls. Remediation was underway. No material legal proceedings were reported.
Most important facts to verify
- Confirm the issuer: the supplied filing is for Five Oaks Investment Corp. (NYSE: OAKS), not Lument Finance Trust, Inc.
- Reconcile reported earnings with the substantial realized investment-sale losses, derivative gains, and AOCI decline; assess how much is recurring versus market-driven.
- Check the duration, renewal terms, collateral haircuts, counterparty concentration, and liquidity available against $563.5 million of GAAP repo debt and potential margin calls.
- Review the assumptions behind book value and interest-rate sensitivity, and monitor whether rate and spread moves continue to affect asset values and dividends.
- Assess Non-Agency delinquency, credit enhancement, ratings, geographic concentration, and the adequacy of designated credit reserves.
- Track remediation and subsequent reporting on the material weakness and significant deficiency, along with REIT qualification and taxable-income distribution requirements.