Business context and reporting period
Filing identity differs from the request: the supplied 10-K is for Five Oaks Investment Corp. (NYSE: OAKS), not Lument Finance Trust, Inc. It reports the fiscal year ended December 31, 2013; quarterly figures below refer to the quarter ended December 31, 2013. The company was an externally managed mortgage REIT investing in Agency and Non-Agency RMBS, financed principally with short-term repurchase agreements.
Key financial metrics
| Metric | FY 2013 / December 31, 2013 | Comparable information |
|---|---|---|
| Interest income | $18.9 million | $1.7 million for May 16–December 31, 2012; periods are not comparable in length or scale |
| Net interest income | $14.2 million | $1.4 million for May 16–December 31, 2012 |
| Net income | $3.2 million; $3.18 million attributable to common stockholders, or $0.52 per weighted-average share | $4.8 million; $2.91 per share for May 16–December 31, 2012 |
| Other income (loss) | Loss of $6.1 million, including $31.6 million realized investment-sale losses | $4.4 million income for May 16–December 31, 2012 |
| Operating expenses | $4.9 million | $0.9 million for May 16–December 31, 2012 |
| Operating cash flow | $13.3 million | $0.9 million for May 16–December 31, 2012 |
| Assets / repurchase debt / equity | $528.2 million / $412.2 million GAAP / $113.9 million | At December 31, 2012: $97.0 million / $63.4 million / $32.3 million |
| Cash and liquidity | $33.1 million unrestricted cash and $13.3 million restricted cash | Company reported that available liquidity and borrowing capacity were expected to meet anticipated short-term needs |
| Leverage | 3.6x equity on a GAAP basis; 4.2x including financing underlying Linked Transactions | 2.0x and 2.4x, respectively, at December 31, 2012; year-end comparison is qualified by the 2013 IPO |
At year-end, GAAP RMBS fair value was $445.0 million, with a further $33.4 million net asset balance for Linked Transactions. On the company’s non-GAAP basis, including the underlying securities, RMBS fair value was $539.6 million: 70.8% Agency and 29.2% Non-Agency. The reported non-GAAP portfolio yield was 4.23%; Agency and GAAP-reported Non-Agency yields were 2.70% and 7.83%, respectively. These non-GAAP measures supplement, and do not replace, GAAP results.
Common dividends declared for 2013 totaled $1.64 per share. The board set monthly common dividends of $0.125 per share for January–March 2014. Year-end book value was $12.97 per common share; management reported a 4.8% increase from September 30, 2013.
Material changes versus the prior period
- The March 2013 IPO and concurrent private placement generated approximately $84.0 million net proceeds; the December preferred offering generated approximately $18.1 million net proceeds.
- The portfolio grew substantially and shifted from a high concentration in 30-year fixed-rate Agency RMBS toward Non-Agency credit exposure and shorter-duration Agency hybrid ARMs. GAAP leverage fell from 7.9x at March 31, 2013 to 3.6x at year-end.
- FY 2013 net income and earnings per share were below the 2012 short-period results, while net interest income rose with portfolio growth. Management attributed weaker annual profitability and return on equity partly to 2013 market volatility and realized losses from reducing Agency holdings. The periods are not directly comparable.
- For Q4 2013, common-stockholder net income was $10.7 million, or $1.45 per share, versus $1.4 million, or $0.83 per share, in Q4 2012. The filing attributes the increase to higher net interest income, Linked Transaction gains and gains on interest-rate hedges.
- Other comprehensive loss was $13.5 million for 2013, primarily reflecting unrealized losses on available-for-sale securities; these marks reduced equity, although they are distinct from realized investment-sale losses.
Outlook, risks, and unusual items
- No specific earnings or return guidance is provided. Management expects market conditions to continue influencing results and says investment and financing strategies may be adjusted as opportunities and risks change.
- Management reported that Q4 market value gains in Non-Agency RMBS and higher long-term rates that increased derivative values contributed to the quarter-end book-value increase. The annual results also included substantial realized losses on security sales and volatile derivative results. Derivatives were not designated for hedge accounting, increasing reported earnings volatility.
- Key risks include changes in interest rates, yield-curve flattening, prepayments, Non-Agency credit losses, asset valuation, and the availability or cost of short-term repo financing. Falling collateral values or higher haircuts can trigger margin calls or forced sales. The company reported meeting margin calls during 2013 and compliance with repo covenants at year-end.
- Non-Agency exposure included Alt-A and subprime securities; on the combined non-GAAP basis, 24.2% of underlying loans were 60 or more days delinquent and average remaining credit enhancement was 0.4%. California represented 32.8% of Non-Agency fair value. These figures describe exposure, not realized loss rates.
- After year-end, the company raised approximately $35.1 million net from a common-stock offering, received approximately $2.8 million net from the preferred-stock underwriters’ option, and FOAC entered a $125 million maximum-capacity, 364-day repo facility to finance prime jumbo mortgage loans. These developments were not included in year-end balances.
- The company said a previously identified material weakness and one significant deficiency in financial reporting controls had been remediated by December 31, 2013. Management found disclosure controls effective, but the 10-K included no management assessment or auditor attestation of internal control over financial reporting under the newly public company transition relief.
Most important facts for investors to verify
- Confirm the issuer: this filing is for Five Oaks Investment Corp., not Lument Finance Trust, Inc.
- Review the reconciliation and economic substance of Linked Transactions when comparing GAAP and non-GAAP assets, debt, leverage, portfolio allocation, and returns.
- Assess whether dividends are supported by recurring earnings and cash generation, given 2013 common dividends declared exceeded net income attributable to common stockholders.
- Validate Non-Agency collateral performance, credit-reserve assumptions, delinquency trends, and the concentration of exposures by vintage and geography.
- Examine repo maturities, lender concentration, collateral haircuts, margin-call capacity, and the post-year-end loan-financing facility and guaranty.
- Track the effect of interest rates and hedges on net interest income, book value, liquidity, and reported earnings, including the assumptions behind management’s sensitivity analysis.