Filing summary: Five Oaks Investment Corp. — Q3 2013
Entity and period: The supplied filing is Five Oaks Investment Corp.’s unaudited Form 10-Q for the quarter ended September 30, 2013, not a filing identified as Lument Finance Trust, Inc. Five Oaks was an externally managed mortgage REIT investing primarily in Agency and Non-Agency residential mortgage-backed securities (RMBS). It commenced operations in May 2012 and became publicly traded in March 2013; the filing cautions that comparisons with 2012 are not directly comparable.
Financial and operating highlights
| Metric | Q3 / September 30, 2013 | Comparison or context |
|---|---|---|
| Interest income / expense | $4.34 million / $0.79 million for Q3; $14.93 million / $4.12 million for the first nine months | Q3 2012: $0.73 million / $0.13 million |
| Net interest income | $3.55 million for Q3; $10.81 million for the first nine months | Q3 2012: $0.60 million |
| Net income (loss) attributable to common shareholders | Loss of $17.01 million in Q3; loss of $7.52 million for the first nine months | Q3 2012: income of $3.66 million. Nine-month 2012 comparison covers only May 16–September 30. |
| Basic and diluted EPS | $(2.31) for Q3; $(1.32) for the first nine months | Q3 2012: $2.21 |
| Cash flows | First nine months: $10.31 million operating cash provided; $372.03 million investing cash used; $374.46 million financing cash provided | Cash and cash equivalents ended at $16.34 million; restricted cash was $13.69 million. |
| Assets / equity | Total assets $473.73 million; stockholders’ equity $91.49 million | At December 31, 2012: $97.05 million and $32.27 million, respectively. |
| Debt and leverage | Repurchase agreements $377.04 million on a GAAP basis; $419.6 million including financing underlying Linked Transactions. GAAP debt-to-equity 4.1x; 4.6x including Linked Transactions. | Repurchase borrowings were short term; most had less than 30 days remaining. Weighted-average GAAP borrowing rate was 0.56%. |
| Portfolio | GAAP RMBS fair value $417.55 million: $359.85 million Agency and $57.70 million Non-Agency. Combined non-GAAP RMBS fair value, including Linked Transactions, was $483.36 million. | Management shifted allocations away from Agency and toward Non-Agency RMBS during the quarter. |
| Dividends / book value | $1.28 per common share declared for 2013 through September; book value $12.38 per share at quarter-end. | Fourth-quarter 2013 monthly dividend rate announced at $0.125 per share. Book value fell 4.2% from June 30. |
The filing does not provide a clear conventional operating-margin measure. Net interest income increased as the portfolio and related financing expanded, but reported results were dominated by investment-sale and derivative marks and losses.
Material changes and management commentary
- Q3’s $17.01 million common-stockholder loss reflected a $17.08 million realized loss on investment sales, $10.27 million of unrealized derivative losses and a $0.15 million loss on Linked Transactions, partly offset by $8.40 million of realized derivative gains. For the first nine months, realized investment-sale losses were $31.36 million, while realized derivative gains were $19.47 million.
- Management attributed the portfolio repositioning and realized sale losses primarily to reductions in Agency RMBS amid heightened fixed-income and mortgage-market volatility, including rate volatility following discussion of Federal Reserve tapering. At September 30, Agency RMBS were $359.9 million versus $557.6 million at June 30; Non-Agency RMBS were $57.7 million versus $32.7 million.
- Repurchase borrowings and leverage decreased from June 30 as Agency holdings were reduced. Management expected overall leverage generally to range from three to six times equity, depending on asset mix; stated asset-class ranges were six to nine times for Agency RMBS, one to two times for Legacy Non-Agency RMBS, and one to three times for New Issue Non-Agency RMBS.
- Management said available liquidity and borrowing capacity were expected to meet anticipated short-term needs, but long-term requirements depend on access to debt and equity financing. The company had $16.3 million of unrestricted cash and reported that margin calls during the period were met promptly.
Risks, contingencies, and unusual disclosures
- Funding and liquidity: Short-term repurchase financing is secured by RMBS and subject to collateral marks, margin calls, haircuts, renewal risk, and counterparty decisions. Haircuts ranged from 3% to 50%, with a weighted average of about 10%. A sufficiently large collateral decline or tighter haircuts could force asset sales.
- Market, rate, and prepayment risk: Rising rates may reduce asset values, increase financing costs, and weaken net interest income; changes in prepayments can also alter yields and hedge effectiveness. The company’s sensitivity analysis estimated that a parallel 100-basis-point rate increase would reduce projected net interest income by 4.80% and Agency portfolio value by 0.78%; these are model-based estimates, not forecasts.
- Credit concentration: Combined Non-Agency RMBS had 26.6% 60-plus-day delinquencies and only 0.1% average remaining credit enhancement. About 70.6% was unrated; California represented 32.3% of that portfolio’s fair value.
- Derivatives and accounting volatility: Derivatives were not designated for hedge accounting, so fair-value changes flowed through earnings. The filing also describes Linked Transactions accounted for as derivatives, while providing non-GAAP portfolio and financing figures that include their underlying RMBS.
- Internal controls: Management reported that a previously identified material weakness relating to accounting for Linked Transactions, and one significant deficiency, remained under remediation. Disclosure controls were described as effective except for these matters.
- REIT and other matters: REIT status depends on meeting ongoing tax and distribution tests. No material legal proceedings were reported, and the company said there were no material changes to previously disclosed risk factors. Certain indemnification obligations had unlimited maximum potential payments, but no liability was recorded because estimated fair value was minimal.
Most important facts for investors to verify
- Confirm that this Five Oaks Investment Corp. filing is the intended filing; the request names Lument Finance Trust, Inc.
- Review the drivers, timing, and sustainability of investment-sale losses and derivative gains/losses, including the effect of non-hedge accounting.
- Assess repurchase-agreement renewal, counterparty concentration, collateral haircuts, margin-call capacity, and the difference between GAAP and non-GAAP borrowing and leverage.
- Evaluate the credit quality, delinquency exposure, valuation assumptions, and concentration of the Non-Agency RMBS portfolio.
- Track remediation of the material weakness and significant deficiency, and confirm the company’s filing-status representation: the cover page appears to mark “No” for having filed all required reports during the preceding 12 months.
- Check dividend coverage against taxable income and available cash, and whether the announced monthly dividend rate is maintained.