Search the web
Welcome, Guest
[Sign Out, My Account]
EDGAR_Online

Quotes & Info
Enter Symbol(s):
e.g. YHOO, ^DJI
Symbol Lookup | Financial Search
OAKS > SEC Filings for OAKS > Form 10-K on 12-Mar-2014All Recent SEC Filings

Show all filings for FIVE OAKS INVESTMENT CORP.

Form 10-K for FIVE OAKS INVESTMENT CORP.


12-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

The following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes included in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that reflect our current expectations, estimates, forecast and projections.

Overview

We are a Maryland corporation focused on investing in, financing and managing a leveraged portfolio of mortgage-backed securities, including non-Agency and Agency residential mortgage-backed securities, or RMBS, Multi-Family MBS, residential mortgage loans, MSRs and other mortgage-related investments, which we collectively refer to as our target assets.

Our objective is to provide attractive risk-adjusted returns to our investors, primarily through dividends and secondarily through capital appreciation. To achieve this objective, we currently, or expect to, invest in the following assets:

Agency RMBS, which are residential mortgage-backed securities, for which a U.S. Government agency such as Ginnie Mae or a federally chartered corporation such as Fannie Mae or Freddie Mac, guarantees payments of principal and interest on the securities;

Non-Agency RMBS, which are RMBS that are not issued or guaranteed by a U.S. Government-sponsored entity; and

Residential mortgage loans and other mortgage-related investments, including securitizations backed by multi-family mortgage loans, or Multi-Family MBS, and mortgage servicing rights, or MSRs.

We finance our current investments in Agency RMBS and Non-Agency RMBS (including Non-Agency RMBS underlying Linked Transactions) primarily through short-term borrowings structured as repurchase agreements.

We are externally managed and advised by Oak Circle Capital Partners LLC pursuant to a management agreement between us and Oak Circle. Oak Circle, which was formed for the purpose of becoming our Manager, manages us exclusively and, unless and until Oak Circle agrees to manage any additional investment vehicle, it will not have to allocate investment opportunities in our target assets with any other REIT, investment pool or other entity. As our Manager, Oak Circle implements our business strategy, performs investment advisory services and activities with respect to our assets and is responsible for performing all of our day-to-day operations. Oak Circle is an investment adviser registered with the SEC.

We elected to be taxed as a REIT commencing with our short taxable year ended December 31, 2012, and comply with the provisions of the Internal Revenue Code with respect thereto. Accordingly, we are generally not subject to federal income tax on our REIT taxable income that we currently distribute to our stockholders so long as we maintain our qualification as a REIT. Our continued qualification as a REIT depends on our ability to meet, on a continuing basis, various complex requirements under the Internal Revenue Code relating to, among other things, the source of our gross income, the composition and values of our assets, our distribution levels and the concentration of ownership of our capital stock. Even if we maintain our qualification as a REIT, we may be subject to some federal, state and local taxes on our income.

2013 Highlights

We completed our IPO and a concurrent private placement of 1,666,667 shares of our common stock to XL Investments achieving net proceeds to us of approximately $84.0 million.

We raised additional equity capital through our Series A Preferred Offering, resulting in additional net proceeds to us of approximately $18.1 million.

We transitioned the investment portfolio from a high concentration on 30-year fixed-rate Agency RMBS immediately following our IPO to an increased concentration on Non-Agency RMBS credit risk and shorter duration hybrid-ARMs within the Agency RMBS portfolio. As a result, GAAP leverage declined from 7.9 times as of March 31, 2013 to 3.6 times as of December 31, 2013.

Our external manager, Oak Circle Capital Partners, LLC, or our Manager, hired David Akre to lead our effort into the aggregation and securitization of prime jumbo residential mortgage loans, seeking to take advantage of his lengthy prior experience in this sector, and established Five Oaks Acquisition Corp., or FOAC, as a taxable REIT subsidiary, or TRS, to acquire prime jumbo residential mortgage loans and the mortgage loan servicing rights, or MSRs, with respect to such loans.

We received an invitation to bid on subordinated mortgage-backed securities, or MBS, investments in multi-family securitizations sponsored by Freddie Mac, known as the K-Series.

Subsequent Developments

In January 2014, the underwriters of our Series A Preferred Offering exercised their option to purchase an additional 120,000 shares of Series A Preferred Stock, resulting in total net proceeds of $2.8 million.

On February 24, 2014, we completed a public offering of 3,000,000 shares of common stock, resulting in net proceeds to us of approximately $32.0 million. On March 7, 2014, the underwriters purchased an additional 300,000 shares of common stock, resulting in additional net proceeds of $3.1 million, for total net proceeds of $35.1 million.

On February 25, 2014, FOAC entered into a Master Repurchase Agreement by and among Credit Suisse First Boston Mortgage Capital LLC, as buyer, FOAC, as seller, and the Company, as guarantor, for the purpose of financing the acquisition of prime jumbo residential mortgage loans and other approved mortgage loans, in furtherance of the Company's previously announced strategy to aggregate and securitize such loans. The Repurchase Agreement provides for a 364-day facility term with an aggregate maximum capacity of $125,000,000 which is scheduled to mature on February 24, 2015 unless extended pursuant to its terms.

Recently Formed Taxable REIT Subsidiary

On June 10, 2013, we established FOAC in furtherance of our strategy to increase the range of our investments in mortgage-related assets other than RMBS. FOAC is a Taxable REIT Subsidiary, or TRS, whose purposes will include the acquisition and disposition of residential mortgage loans and MSRs with respect to such loans. FOAC does not intend to originate the loans and does not intend to participate in the credit or underwriting decisions prior to loan origination, but does intend to accumulate the loans for subsequent securitization. FOAC has obtained authorizations from substantially all of the 32 states that currently impose restrictions on buying, selling or owning residential mortgage loans, or owning the servicing rights with respect to residential mortgage loans. We believe that FOAC now has sufficient licenses to commence its operations, although it may continue to pursue authorizations in additional states

Factors Impacting Our Operating Results

The results of our operations will be affected by a number of factors and primarily depend on, among other things, the level of our net interest income, the market value of our assets and the supply of, and demand for, our target assets in the marketplace. Our net interest income, which reflects the amortization of purchase premiums and accretion of purchase discounts, will vary primarily as a result of changes in market interest rates and prepayment speeds, as measured by the constant prepayment rate, or CPR, on our RMBS. Interest rates vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. Our operating results may also be impacted by unanticipated credit events experienced by borrowers whose mortgage loans are included in our RMBS. Our operating results will also be affected by general U.S. residential real estate fundamentals and the overall U.S. economic environment. In particular, our strategy is influenced by the specific characteristics of the residential real estate markets, including prepayment rates, credit and interest rate levels.

Market conditions. Due to the significant repricing of real estate assets and the continuing uncertainty in the direction of the real estate markets, we believe a void in the debt and equity capital available for investing in real estate has been created as many financial institutions, insurance companies, finance companies and fund managers have determined to reduce or discontinue investment in debt or equity related to real estate. We believe the dislocations in the residential real estate market have resulted or will result in an "over-correction" in the repricing of real estate assets, creating a potential opportunity for us to capitalize on these market dislocations and capital void.

Although we believe that mortgage-related assets continue to offer potentially attractive investment opportunities for us, the increase in fixed income and mortgage market volatility during 2013 has impacted our Manager's views of risk and return, and increased the potential variability of our operating results. On June 19, 2013, the U.S. Federal Reserve reaffirmed its commitment to QE3, including a continuation of exceptionally low levels for the federal funds rate for so long as unemployment remains above 6.5% and inflation remains at or below 2.5%, as well as the continued purchase of Agency RMBS at a pace of $40 billion per month, and longer-term Treasury securities at a pace of $45 billion per month. However, in a press conference on the same day, Federal Reserve Chairman Ben Bernanke indicated that economic growth appeared strong enough to contemplate reducing the pace of purchases during the second half of 2013, and ending purchases around the middle of 2014, providing subsequent economic data was broadly consistent with Federal Reserve expectations. This discussion of so-called "tapering" triggered significant increases in the level and the volatility of long-term interest rates. Having closed the first quarter at 1.85%, the 10-year Treasury yield dropped below 1.7% in early May 2013, before rising almost 70% to over 2.7% by early July. Rates remained volatile in the third quarter, with the 10-year yield touching 3.01% before dropping again to end the third quarter at 2.61%. On December 18, 2013, the U.S. Federal Reserve announced that in light of improved economic conditions, starting in January 2014, it would reduce its monthly purchases of Agency RMBS and longer-term Treasury securities to $35 billion and $40 billion, respectively. On January 29, 2014, the Federal Reserve announced that it would further reduce its monthly purchases of Agency RMBS and Treasury securities to $30 billion and $35 billion, respectively. We expect that market conditions will continue to impact our operating results and will cause us to adjust our investment and financing strategies over time as new opportunities emerge and risk profiles of our business change. In light of the recent increase in market volatility, such adjustments may be more frequent than they have been in the past.

Changes in market interest rates. With respect to our business operations, increases in interest rates, in general, may over time cause: (1) the value of our RMBS portfolio to decline; (2) coupons on our adjustable-rate and hybrid RMBS to reset, although on a delayed basis, to higher interest rates;
(3) prepayments on our RMBS portfolio to slow, thereby slowing the amortization of our purchase premiums and the accretion of our purchase discounts; (4) the interest expense associated with our borrowings to increase; and (5) to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to increase. Conversely, decreases in interest rates, in general, may over time cause: (1) prepayments on our RMBS portfolio to increase, thereby accelerating the amortization of our purchase premiums and the accretion of our purchase discounts; (2) the value of our RMBS portfolio to increase; (3) coupons on our adjustable-rate and hybrid RMBS to reset, although on a delayed basis, to lower interest rates; (4) the interest expense associated with our borrowings to decrease; and (5) to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to decrease.

Prepayment speeds: Prepayment speeds, as reflected by the CPR, vary according to interest rates, the type of residential mortgage loan, conditions in financial markets and housing markets, availability of residential mortgages, borrowers' credit profiles, competition and other factors, none of which can be predicted with any certainty. CPR, expressed as a percentage over a pool of residential mortgages, is the rate at which principal is expected to prepay in the given year (usually the next one). For example, if a certain residential mortgage loan pool has a CPR of 9%, then 9% of the existing pool principal outstanding is expected to prepay over the next year. In general, when interest rates rise, it is relatively less attractive for borrowers to refinance their residential mortgage loans, and as a result, prepayment speeds tend to decrease. When interest rates fall, however, prepayment speeds tend to increase. When house price appreciation is positive, prepayment rates may increase, and when house prices depreciate in value, prepayment rates may decline. For RMBS purchased at a premium, as prepayment speeds increase, the amount of income we will earn on these investments will be less than expected because the purchase premium we will pay for the bonds amortizes faster than expected. Conversely, decreases in prepayment speeds result in income greater than expected and can extend the period over which we amortize the purchase premium. For RMBS purchased at a discount, as prepayment speeds increase, the amount of income we will earn will be greater than expected because of the acceleration of the accretion of the discount into interest income. Conversely, decreases in prepayment speeds result in income less than expected and can extend the period over which we accrete the purchase discount into interest income.

Changes in market value of our assets. It is our business strategy to hold our target assets as long-term investments. As such, we expect that our securities will be carried at their fair value, as available-for-sale, or AFS, when applicable, in accordance with ASC 320-10 "Investments-Debt and Equity Securities," with changes in fair value recorded through accumulated other comprehensive income/(loss), a component of stockholders' equity, rather than through earnings. As a result, we do not expect that changes in the market value of the assets will normally impact our operating results. However, at least on a quarterly basis, we monitor our target assets for other-than-temporary impairment, which could result in our recognizing a charge through earnings. See "-Critical Accounting Policies" for further details.

Credit risk. We expect to be subject to varying degrees of credit risk in connection with our Non-Agency RMBS portfolio. Our Manager seeks to mitigate this credit risk by estimating expected losses on these Non-Agency RMBS assets and purchasing such assets at appropriately discounted prices. These discounted purchase prices will take into account any available credit support and estimated expected losses in seeking to produce attractive loss-adjusted returns. Nevertheless, unanticipated credit losses could occur, which could adversely impact our operating results.

Governmental actions. Since 2008, when both Fannie Mae and Freddie Mac were placed under the conservatorship of the U.S. government, there have been a number of proposals to reform the U.S. housing finance system in general, and Fannie Mae and Freddie Mac in particular. These proposals include the February 2011 U.S. Treasury report entitled " Reforming America's Housing Finance Market ", and the October 2012 Federal Housing Finance Authority's white paper entitled " Building a New Infrastructure for the Secondary Mortgage Market ". More recently, there have been a number of other proposals introduced, both from industry groups and by the U.S. Congress. The most recent bills in Congress to receive serious consideration are the Housing Finance Reform and Taxpayer Protection Act of 2013, also known as the Corker-Warner bill, and the Protecting American Taxpayers and Homeowners Act. These bills, while different in a number of respects, share certain notable commonalities. Among other things, both would eliminate Freddie Mac and Fannie Mae and would seek to increase the opportunities for private capital to participate in the provision of mortgage credit. It remains unclear whether these or any other proposals will become law or, should such a proposal become law, if or how the enacted law will differ from the current draft of the bill. It is unclear how the proposals would impact housing finance, and what impact, if any, it will have on mortgage REITs.

Investment Activities

As of December 31, 2012, we operated as a private company, and owned $81.0 million of RMBS on a GAAP basis, of which $70.0 million was in Agency RMBS and $11.0 million was in Non-Agency RMBS. As of December 31, 2012, we owned $103.6 million of RMBS on a non-GAAP basis (including Non-Agency RMBS underlying Linked Transactions), of which $70.0 million was in Agency RMBS and $33.6 million was in Non-Agency RMBS. Of the $33.6 million, $22.6 million was in Non-Agency RMBS underlying Linked Transactions. Following the closing of our initial public offering, or IPO and our concurrent private placement on March 27, 2013, we concentrated the initial investment of the net proceeds of these offerings in Agency RMBS, due to the size and liquidity of this market together with the relatively attractive investment conditions prevailing at the end of the first quarter. During the second quarter, and consistent with our strategy, we selectively increased our allocation to Non-Agency RMBS as attractive opportunities presented themselves, and accordingly began to sell certain of our Agency RMBS positions. We accelerated the reduction of our Agency RMBS portfolio as fixed income and mortgage market volatility increased, particularly after June 19, 2013, and in the third and fourth quarters we continued with this strategy of shifting our relative portfolio allocations from Agency RMBS to Non-Agency RMBS. As of December 31, 2013, on a GAAP basis we had increased our overall investments in RMBS to $445.0 million, compared to $417.6 million as of September 30, 2013. Within this total, we had modestly increased our Agency RMBS from $359.9 million to $382.3 million, and increased our Non-Agency RMBS from $57.7 million to $62.7 million, respectively, from quarter-end to quarter-end. However, the relative increase in our Non-Agency RMBS assets is more clearly shown by analyzing the portfolio on a non-GAAP basis. As of December 31, 2013, we owned $539.6 million of RMBS on a non-GAAP basis (including Non-Agency RMBS underlying Linked Transactions), of which $382.3 million was in Agency RMBS and $157.3 million was in Non-Agency RMBS. Of the $157.3 million, $94.6 million was in Non-Agency RMBS underlying Linked Transactions. As of December 31, 2013, we had entered into master repurchase agreements with 24 counterparties, and we had borrowed $412.2 million, on a GAAP basis, and $473.4 million, on a non-GAAP basis (including the repurchase agreement financing associated with the Non-Agency RMBS underlying Linked Transactions) under 14 of these agreements. This compares to $63.4 million, on a GAAP basis, and $77.4 million, on a non-GAAP basis, respectively, as of December 31, 2012. The increase in borrowings between periods is a direct result of the increase in our RMBS holdings. We have also entered into interest rate swap and swaption agreements designed to mitigate the effects of increases in interest rates under a portion of our repurchase agreements. During the fourth quarter, we maintained the notional amount of swap agreements at $338.0 million as of December 31, 2013. We maintained the notional amount of our swaption agreements at $25.0 million as of December 31, 2013, while increasing the range of other derivative instruments used during the quarter to help mitigate interest rate and other market risks, including Agency to be announced securities, or TBAs, and U.S. Treasury futures. We used TBAs during the period, and had $25.0 million TBAs outstanding as of December 31, 2013; as of the same date, we had 100 futures contracts outstanding, representing a notional amount of $10.0 million.

We use leverage to increase potential returns to our stockholders. To that end, subject to maintaining our qualification as a REIT and our exclusion from registration under the Investment Company Act, we use borrowings to fund the origination or acquisition of our target assets. We accomplish this by borrowing against existing assets through repurchase agreements. Neither our organizational documents nor our investment guidelines places any limit on the maximum amount of leverage that we may use, and we are not required to maintain any particular debt-to-equity leverage ratio. We may also change our financing strategy and leverage without the consent of our stockholders.

As of December 31, 2013, we borrowed 3.6 times our stockholders' equity (calculated in accordance with GAAP); 4.2 times after including repurchase agreements underlying Linked Transactions (calculated on a non-GAAP basis). This compares to leverage of 2.0 times and 2.4 times, respectively, as of December 31, 2012. However, since we were operating as a private company prior to our IPO in March 2013, our leverage ratios at year-end 2012 and 2013 are not directly comparable. We expect our leverage (on both a GAAP and non-GAAP basis) will range between three and six times the amount of our stockholders' equity, depending upon the relative allocation to Agency RMBS, Non-Agency RMBS and other mortgage-related investments. We expect to borrow between six to nine times the amount of our stockholders' equity in acquiring Agency RMBS, between one and two times when acquiring Legacy Non-Agency RMBS, between one to three times when acquiring New Issue Non-Agency RMBS and between one and four times when acquiring Multi-Family MBS. The leverage our Manager is comfortable applying to each asset class at any point in time is a function of the yield profile across housing environments and also a function of price or market values in environments of excessive volatility. The reduction in our leverage during the period was principally due to the continued reduction in our relative portfolio allocation to Agency RMBS, and the concomitant increase in our Non-Agency RMBS outstandings. Depending on the different cost of borrowing funds at different maturities, we vary the maturities of our borrowed funds to attempt to produce lower borrowing costs and reduce interest rate risk. Generally, we seek to enter into collateralized borrowings only with institutions that are rated investment grade by at least one nationally-recognized statistical rating organization. As we seek to continue expanding the range of available financing sources, we have borrowed and may continue to borrow from institutions that, although not rated investment grade by at least one nationally recognized statistical rating organization, in the assessment of our management team represent an acceptable counterparty credit risk in providing collateralized financing for our portfolio. Nonetheless, we expect that the preponderance of our sources of collateralized borrowings (84.4% as of December 31, 2013) will continue to either have an investment grade rating directly or be part of a group of companies which includes an institution that has such a rating.

The leverage that we employ is specific to each asset class in which we invest and will be determined based on several factors, including potential asset price volatility, margin requirements, the current cycle for interest rates, the shape of the yield curve, credit, security price, the outlook for interest rates and our ability to use and the effectiveness of interest rate hedges. We analyze both historical interest rate and credit volatility and market-driven implied volatility for each asset class in order to determine potential asset price volatility. Our leverage targets attempt to risk-adjust asset classes based on each asset class's potential price volatility. The goal of our leverage strategy is to ensure that, at all times, our investment portfolio's leverage ratio is appropriate for the level of risk inherent in the investment portfolio and that each asset class has individual leverage targets that are appropriate for its potential price volatility.

As of December 31, 2013, our Agency RMBS portfolio had a weighted average nominal coupon of 3.00% at a weighted average amortized cost of $102.9 per $100 of nominal, or face, value, or $397.7 million total cost. As of December 31, 2013, the weighted average market price of our Agency portfolio was $98.9 per $100 of nominal, or face, value, or $382.3 million in the aggregate. All of our Agency securities represent whole pool securities. As of December 31, 2012, our Agency RMBS portfolio had a weighted average nominal coupon of 3.45% at a weighted average amortized cost of $104.9 per $100 of nominal, or face, value, or $68.5 million total cost. As of December 31, 2012, the weighted average market price of our Agency portfolio was $107.1 per $100 of nominal, or face, value, or $70.0 million in the aggregate. All of our Agency securities represent whole pool securities. The notable year-over-year decline in weighted average nominal coupon, weighted average amortized cost and weighted average market price of our Agency portfolio is primarily due to our reduced allocation to 30-year fixed-rate Agency RMBS in favor of lower coupon, lower priced hybrid ARMs.

As of December 31, 2013, our Non-Agency RMBS portfolio, on a GAAP basis, had a weighted average nominal coupon of 0.39% at a weighted average amortized cost of $61.2 per $100 of nominal, or face, value, or $58.4 million total cost. As of December 31, 2013, the weighted average market price of our Non-Agency RMBS portfolio, on a GAAP basis, was $65.7 per $100 of nominal, or face, value, or $62.7 million in the aggregate. As of December 31, 2012, our Non-Agency RMBS portfolio, on a GAAP basis, had a weighted average nominal coupon of 0.67% at a weighted average amortized cost of $54.5 per $100 of nominal, or face, value, or $10.1 million total cost. As of December 31, 2012, the weighted average market price of our Non-Agency RMBS portfolio, on a GAAP basis, was $59.7 per $100 of nominal, or face, value, or $11.0 million in the aggregate.

As of December 31, 2013, our Non-Agency RMBS portfolio on a non-GAAP basis (including Non-Agency RMBS underlying Linked Transactions) had a weighted average nominal coupon of 0.41% at a weighted average amortized cost of $60.0 per $100 of nominal, or face, value, or $146.6 million total cost. As of December 31, 2013, the weighted average market price of our Non-Agency RMBS portfolio on a non-GAAP basis (including Non-Agency RMBS underlying Linked Transactions) was $64.4 per $100 of nominal, or face, value, or $157.3 million in the aggregate. As of December 31, 2012, our Non-Agency RMBS portfolio on a non-GAAP basis (including Non-Agency RMBS underlying Linked Transactions) had a weighted average nominal coupon of 0.70% at a weighted average amortized cost of $50.6 per $100 of nominal, or face, value, or $28.8 million total cost. As of December 31, 2012, the weighted average market price of our Non-Agency RMBS portfolio on a non-GAAP basis (including Non-Agency RMBS underlying Linked Transactions) was $59.3 per $100 of nominal, or face, value, or $33.6 million in the aggregate.

The year-over-year increase in the weighted average market price of our Non-Agency RMBS portfolio on both a GAAP and a non-GAAP basis primarily reflects the overall increase in Non-Agency RMBS prices, particularly in the fourth quarter of 2013.

Investment Portfolio

The following tables summarize certain characteristics of our investment portfolio as of December 31, 2013 and December 31, 2012, respectively: (1) as reported in accordance with GAAP, which excludes the Non-Agency RMBS underlying our Linked Transactions, (2) to show separately the Non-Agency RMBS underlying our Linked Transactions; and (3) on a non-GAAP combined basis (which reflects the inclusion of the Non-Agency RMBS underlying our Linked Transactions combined with our GAAP-reported RMBS):

December 31, 2013

GAAP Basis

. . .
  Add OAKS to Portfolio     Set Alert         Email to a Friend  
Get SEC Filings for Another Symbol: Symbol Lookup
Quotes & Info for OAKS - All Recent SEC Filings
Copyright © 2014 Yahoo! Inc. All rights reserved. Privacy Policy - Terms of Service
SEC Filing data and information provided by EDGAR Online, Inc. (1-800-416-6651). All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Neither Yahoo! nor any of independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. By accessing the Yahoo! site, you agree not to redistribute the information found therein.