Business context and reporting period
The supplied filing is Five Oaks Investment Corp.’s Form 10-K for the fiscal year ended December 31, 2015—not a filing under the requested company name, Lument Finance Trust, Inc. Five Oaks was an externally managed mortgage REIT investing in Agency and Non-Agency RMBS, Multi-Family MBS, residential mortgage loans and mortgage servicing rights (MSRs). Results include four consolidated securitization trusts whose assets and liabilities are restricted and whose debt is non-recourse to Five Oaks.
Financial results and position
| Metric | FY 2015 | FY 2014 / comparison |
|---|---|---|
| Interest income | $114.4 million | $45.8 million |
| Interest expense | $83.1 million | $27.8 million |
| Net interest income | $31.3 million | $18.0 million |
| Net income | $0.45 million | $3.31 million |
| Net income (loss) attributable to common stockholders | $(3.07) million; $(0.21) per share | $0.43 million; $0.03 per share |
| Comprehensive income (loss) attributable to common stockholders | $(10.68) million | $18.73 million |
| Cash from operating activities | $2.06 million | $20.74 million |
| Common dividends declared | $1.35 per share | $1.47 per share |
Fourth-quarter 2015 net income was $3.48 million, or $0.18 per common share after preferred dividends, versus a common-stockholder loss of $4.49 million, or $0.31 per share, in fourth-quarter 2014. Fourth-quarter 2015 net interest income was $6.54 million.
At year-end, total assets were $2.50 billion, total liabilities $2.32 billion and stockholders’ equity $177.5 million, including $140.3 million of common equity and $37.2 million of preferred equity. Common book value was $9.58 per share, down 19.7% from $11.93 a year earlier. Unrestricted cash was $26.1 million; restricted cash was $8.2 million.
Repurchase agreements and FHLB advances totaled $568.4 million, with a weighted-average repo borrowing rate of 1.19%. The company reported 3.2:1 overall debt-to-equity leverage. Separately, $1.745 billion of securitized trust debt was non-recourse to the company and excluded from its leverage discussion. Reported operating cash flow fell to $2.1 million from $20.7 million.
Material changes versus the prior comparable period
- In response to market volatility and credit-spread widening, Five Oaks reduced Non-Agency RMBS exposure from $303.4 million at year-end 2014 to $121.5 million at year-end 2015, while increasing Agency RMBS from $314.8 million to $375.3 million. Approximately 96% of Agency RMBS was hybrid adjustable-rate securities.
- On a non-GAAP basis, total MBS fair value fell to $686.9 million from $783.9 million; Multi-Family MBS rose to $190.1 million from $165.7 million. Residential mortgage loans held for sale declined to $10.9 million from $62.0 million, mainly following securitization sales.
- Book value and comprehensive results weakened amid second-half spread widening and market volatility. The company reported $3.6 million of other-than-temporary impairment losses, versus none in 2014, and $12.0 million of realized losses on derivatives.
- Year-over-year comparisons are affected by consolidation of the four trusts and adoption of accounting guidance that changed linked repo transactions to gross presentation. The filing cautions that 2015 GAAP results are not directly comparable with 2014.
Outlook, risks and unusual items
- Management adopted a more defensive investment posture from the third quarter of 2015, seeking to enhance liquidity and reduce credit exposure. It said this approach could weigh on results for several quarters, but considered it appropriate for a smaller mortgage REIT. No numerical earnings or return guidance is provided.
- Common dividends were reduced from $0.10 monthly to $0.06 monthly for January–March 2016. The board has not established a minimum common dividend; future payments remain discretionary and dependent on earnings, liquidity, REIT requirements and other factors.
- Liquidity and funding risks include short-term repo dependence, margin calls, refinancing needs, lender concentration and potential forced asset sales. At year-end, $449.1 million of repo borrowings matured in under 30 days. Haircuts ranged from 5% to 55%, averaging 14.68%; the company said it met margin calls during 2015 and was in compliance with financial covenants at year-end.
- The Federal Reserve’s December 2015 rate increase and possible further increases, credit-spread volatility, prepayments, borrower credit performance, property values and securitization-market access could affect income, fair values and liquidity. Interest-rate sensitivity analysis estimated a 22.8% decline in projected net interest income for an immediate 100-basis-point rate rise; management cautioned that actual results could differ materially.
- A February 2016 FHFA rule requires the captive insurance subsidiary to exit FHLB Indianapolis by February 19, 2017. The $49.7 million of advances outstanding at year-end had been repaid and replaced with repo financing by March 15, 2016; the company initiated redemption of $2.4 million of FHLB stock. Management said the rule was not expected to materially affect core operations, but would constrain holding prime jumbo loans for investment.
- Restatement and controls: The company corrected accounting for unrealized losses on two Non-Agency RMBS interest-only securities elected under the fair value option. Losses had been reported in other comprehensive income rather than earnings, requiring restatement of the June and September 2015 interim statements. The adjustments reduced common earnings by $0.23 million for the second quarter and a further $0.39 million for the third quarter; the filing says the affected 10-Qs will not be amended. Management and the Audit Committee concluded that a material weakness existed and that internal control over financial reporting and disclosure controls were ineffective at year-end and in the affected periods. Remediation was underway, but not yet complete.
- The filing also says the 2014 Form 10-K omitted financial statements for the pre-IPO 2012 period; following SEC staff discussions, the company planned to file an amendment. It reported an outstanding SEC comment process and expected to respond to a March 2016 staff letter.
- The independent auditor gave an unqualified opinion on the consolidated financial statements, but did not opine on internal-control effectiveness. The filing reports no pending or threatened legal proceedings known to the company.
Most important facts for investors to verify
- Confirm the issuer identity: this filing is for Five Oaks Investment Corp. (ticker OAKS), not Lument Finance Trust, Inc.
- Review the restated quarterly statements, Note 20, and subsequent filings for the impact and remediation status of the accounting error and control weakness.
- Assess liquidity against near-term repo maturities, collateral haircuts, margin-call exposure and the replacement of FHLB advances with repo funding.
- Reconcile reported GAAP figures with the company’s non-GAAP portfolio and leverage measures, including the effects of trust consolidation and the accounting-standard change.
- Evaluate the sustainability of the reduced common dividend, the $9.58 year-end book value per share and the company’s credit-spread and interest-rate exposure.