Business context and reporting period
This is Five Oaks Investment Corp.’s unaudited Form 10-Q for the three months ended March 31, 2018. The filing is for Five Oaks Investment Corp. (ticker OAKS), not Lument Finance Trust, Inc.; verify the issuer before relying on this summary.
Five Oaks historically invested mainly in residential mortgage-backed securities (RMBS) and related assets. In January 2018, it appointed Hunt Investment Management, LLC as external manager and announced a strategic shift toward transitional floating-rate commercial real estate loans. The company is a REIT.
Financial performance and position
- Income: Net interest income was $3.1 million, down from $5.8 million in Q1 2017. Net income was $11.3 million versus $2.4 million; income attributable to common stockholders was $10.4 million, or $0.45 per diluted share, versus $1.5 million, or $0.08 per share.
- Drivers: Other income was $11.4 million versus $0.2 million, including $15.6 million of realized and unrealized gains on interest-rate futures. This more than offset $2.8 million of realized investment-sale losses and fair-value losses on consolidated mortgage loans. Interest expense rose to $18.4 million from $16.4 million.
- Comprehensive results and book value: Comprehensive loss attributable to common stockholders was $0.4 million, including $10.9 million of other comprehensive loss, principally reflecting unrealized losses on available-for-sale securities. Book value per common share was $4.78, down from $4.91 at year-end. Management reported an economic loss of 0.61% for the quarter, including the $0.10 common dividend.
- Portfolio: Agency RMBS fair value declined to $1.095 billion from $1.285 billion at December 31, 2017. On the company’s non-GAAP combined basis, total MBS fair value was $1.120 billion versus $1.317 billion. The company said the reductions supported its planned commercial real estate reallocation.
- Debt and leverage: Recourse repurchase-agreement borrowings were $1.177 billion, down from $1.235 billion, at a 1.88% weighted-average rate versus 1.56% at year-end. Recourse debt-to-equity was 7.8:1 versus 8.5:1. Separately, consolidated securitization trusts had $1.193 billion of non-recourse debt; these obligations are payable only from trust assets.
- Liquidity and cash flow: Cash and cash equivalents were $42.3 million and restricted cash was $11.7 million at quarter-end. Operating cash flow was $1.9 million, compared with $1.3 million used in Q1 2017. Cash, cash equivalents and restricted cash totaled $53.9 million, up from $45.6 million at the start of the quarter. The filing does not provide a clear net interest margin figure.
- Capital and distributions: Stockholders’ equity was $150.4 million, including $37.2 million of preferred equity. The January private placement issued 1.54 million common shares to a Hunt affiliate for net proceeds of about $7.3 million; the increased share count contributed to per-share book-value dilution. Common dividends declared were $0.10 per share, versus $0.15 in Q1 2017.
Material changes versus the prior comparable period
- Net income and earnings per share improved substantially, primarily because of the swing in unrealized derivative results and lower expenses; net interest income declined as funding costs increased and balances in consolidated trusts amortized.
- Available-for-sale securities had $23.5 million of gross unrealized losses at March 31, compared with $13.4 million at year-end. No credit-related other-than-temporary impairment was recognized in the quarter.
- The external manager changed from Oak Circle to Hunt effective January 18. The new agreement includes a 1.50% annual base fee and, beginning after January 18, 2019, a potential 20% incentive fee on Core Earnings above an 8% annual hurdle.
Outlook, risks, contingencies and unusual items
- Strategy and subsequent events: Management intends to reduce Agency RMBS exposure and move toward commercial real estate lending, subject to arranging suitable financing. After quarter-end, Five Oaks reported selling an additional $605.6 million of Agency RMBS and, on April 30, acquiring Hunt CMT Equity from an affiliate of its manager for $68.05 million. The acquired assets include CLO junior notes and preferred shares, a licensed lender and loan participations; the CLO’s underlying transitional floating-rate loans totaled $346.3 million as of March 31. The acquisition was funded with RMBS sales and available cash.
- Distribution outlook: The company said it intends to make regular quarterly common distributions. It announced a $0.02 monthly common dividend for Q2 2018. Distributions depend on taxable income, liquidity, operating needs and debt service.
- Market and financing risks: Rising rates can increase borrowing costs, reduce asset values and compress net interest income; falling rates can affect prepayments and premium amortization. Short-term repo financing creates refinancing, collateral and margin-call risk. The company met margin calls during the quarter and reported compliance with its financial covenants. Its sensitivity analysis estimated that an immediate 100-basis-point rate increase would reduce projected net interest income by 78.83% and portfolio value, including derivatives, by 0.80%; these are model-based estimates, not forecasts.
- Guarantees: Backstop guarantees tied to MAXEX loans had maximum potential payments of $795.3 million, up from $629.3 million at year-end. Management reported no known circumstance expected to trigger a payment and recognized no contingent liability; the recorded fee-related liability was approximately $274,000. The company also disclosed indemnification obligations whose maximum potential payments are unlimited, with no liability recorded.
- Controls: Management concluded disclosure controls were ineffective at March 31 because of previously identified material weaknesses involving tax review and the review of account balances, including consolidated trusts. Remediation and testing were ongoing; management intended to complete remediation by December 31, 2018, but did not consider the weaknesses remediated at filing.
Important facts for investors to verify
- Confirm the filing belongs to the intended issuer: the document identifies Five Oaks Investment Corp., not Lument Finance Trust, Inc.
- Track the commercial real estate transition, including the post-quarter Hunt CMT acquisition, its related-party terms, financing and subsequent performance.
- Assess whether lower net interest income, higher repo funding costs, leverage and potential margin calls are consistent with the company’s liquidity and distribution plans.
- Review the $795.3 million maximum backstop-guarantee exposure and the circumstances that could create an actual payment obligation.
- Monitor remediation and testing of the disclosed material weaknesses and any effect on the reliability of future reporting.