Lument Finance Trust, Inc. quarterly report, Q3 FY2018

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Filing identity and period

Important identity mismatch: The supplied filing is the Form 10-Q of Hunt Companies Finance Trust, Inc. (formerly Five Oaks Investment Corp.), for the quarter ended September 30, 2018. It is not identified in the filing as Lument Finance Trust, Inc. Verify the issuer before relying on this summary.

The company was shifting from residential mortgage-backed securities and other legacy investments to transitional, floating-rate commercial real estate loans. Its common stock began trading as HCFT in May 2018.

Financial and operating results

  • Third-quarter earnings: Net income was $4.35 million, versus a $4.26 million loss in Q3 2017. Net income attributable to common stockholders was $3.47 million, or $0.15 per share, versus a $5.14 million loss, or $0.23 per share.
  • Nine-month earnings: Net loss attributable to common stockholders was $8.45 million, or $0.36 per share, compared with a $6.82 million loss, or $0.35 per share, in the prior-year period. Net income before preferred dividends was a $5.82 million loss.
  • Net interest income: $5.11 million in Q3 versus $4.75 million; $12.80 million for the nine months versus $15.36 million. The filing does not provide a directly comparable portfolio net interest margin.
  • Other income/loss: Q3 other income was $1.36 million, compared with a $5.95 million loss. Nine-month other loss was $10.90 million, including $33.36 million of net realized investment-sale losses, partly offset by $25.98 million of realized derivative gains.
  • Expenses: Total expenses were $2.12 million in Q3 and $7.73 million for the nine months, down from $3.05 million and $9.80 million, respectively, in 2017. Management cited lower general and administrative costs and limits on manager expense reimbursements.
  • Commercial loan portfolio: $544.6 million across 43 senior secured loans; all were floating-rate, with a weighted-average coupon of 6.5% and weighted-average life of 3.9 years. The manager rated 91.7% of loans moderate risk or better; four loans were rated high risk and none were rated default risk. No loans were on non-accrual and no loan-loss allowance was recorded.
  • Balance sheet and liquidity: Total assets were $680.8 million at September 30, down from $2.61 billion at year-end 2017, primarily reflecting the portfolio transition and sales. Stockholders’ equity was $152.1 million, including $114.9 million of common equity; reported book value was $4.85 per common share. Cash and cash equivalents were $9.9 million, while total cash, cash equivalents and restricted cash were $87.6 million. Most restricted cash was held in CLOs for reinvestment and was not general-purpose liquidity.
  • Debt and leverage: No repurchase agreements remained outstanding (versus $1.23 billion at year-end 2017). CLOs had $510.2 million face value and $503.5 million carrying value; consolidated trust obligations were non-recourse to the company. Recourse debt-to-equity was 0.0:1; total debt-to-equity, including non-recourse debt, was 3.3:1.
  • Cash flow and distributions: Nine-month operating cash flow was $11.1 million; investing activities provided $1.05 billion, chiefly reflecting securities sales and loan activity; financing activities used $1.02 billion. Common dividends declared were $0.22 per share for the first nine months, including $0.06 for Q3. Preferred stock carried an 8.75% annual dividend rate.

Material changes versus prior periods

  • The company sold its remaining available-for-sale securities during 2018 and ended the quarter with no repurchase-agreement debt or interest-rate derivatives. Its strategy and funding model moved toward commercial real estate lending financed primarily through CLOs.
  • In April, the company acquired Hunt CMT Equity LLC; in August, it closed the $285 million Hunt CRE 2018-FL2 CLO. Two commercial CLOs were consolidated at quarter-end.
  • It sold subordinated interests in two legacy securitization trusts during Q2, deconsolidating those trusts. Only one legacy multi-family trust remained consolidated.
  • Comparability with 2017 is limited by the asset sales, financing repayments, trust deconsolidations and new CLO consolidations. Nine-month net interest income fell, while Q3 common-stockholder earnings improved year over year.
  • Common dividends shifted from monthly declarations to quarterly declarations beginning in Q3 2018. The company reported a 2.94% Q3 economic gain on common equity, comprising a $0.08 increase in book value per share and a $0.06 dividend.

Outlook, risks and unusual items

  • Outlook: No earnings or return guidance was provided. Management said it expected available cash, operating cash flow and borrowing capacity to cover anticipated short-term liquidity needs, but said longer-term capital needs would depend on additional debt or equity financing. Management expects higher rates generally to increase net interest income because assets and CLO liabilities are floating-rate. Its sensitivity estimate shows an approximate $106,000 annual net interest income increase for a 25-basis-point rate rise, and an equivalent decrease for a 25-basis-point decline, based on quarter-end positions.
  • Credit and concentration risk: The transition increases exposure to commercial property, borrower and real-estate credit risks. Loans were concentrated in multi-family properties (80.4%) and the Southwest (41.3%). Higher rates can also strain borrowers’ debt service, despite the floating-rate assets.
  • Funding and liquidity risk: Future growth depends partly on access to additional CLO issuance, other financing or equity. Restricted CLO cash cannot be assumed available for corporate needs; assets may be difficult to sell in stressed markets.
  • Guarantee exposure: The company reported a maximum potential future payment amount of $1.179 billion under MAXEX backstop guarantees, while stating it was not aware of circumstances expected to trigger a payment and had not accrued a contingent loss. The recorded noncontingent deferred-income liability was $397,203. The service obligations were scheduled to end December 31, 2018, or earlier at MAXEX’s option; a replacement provider was contemplated.
  • Related-party transactions: Commercial loans were purchased from an affiliate of the manager, and an affiliate acted as placement agent for the 2018 CLO. The filing also describes manager reimbursements and servicing arrangements with manager affiliates.
  • Controls and reporting: Management concluded disclosure controls were ineffective at September 30 because of material weaknesses in internal control over financial reporting. The filing describes prior-period accounting errors requiring amendments and restatements, and says remediation controls were not yet fully operational or demonstrated effective. Management was evaluating whether remediation could be completed by year-end 2018.
  • Other: The company stated there were no material legal proceedings and no recognized loan impairments. REIT qualification, future financing access, loan performance and fair-value estimates remain relevant risks.

Key facts for investors to verify

  1. Confirm issuer identity: the supplied 10-Q names Hunt Companies Finance Trust, Inc., not Lument Finance Trust, Inc.
  2. Review the amendments/restatements referenced in the controls section, the specific corrected periods and the status of remediation after September 30, 2018.
  3. Assess the MAXEX backstop guarantee’s remaining obligations, potential transfer to a replacement provider and required liquidity support.
  4. Examine CLO terms, reinvestment requirements, non-recourse structure and related-party loan purchases, fees and servicing arrangements.
  5. Validate loan credit quality, collateral values, geographic and property concentrations, and the effect of interest-rate changes on borrower performance.
  6. Distinguish unrestricted cash from restricted CLO cash and assess the company’s capacity to fund distributions and future investments.