10-Q/A: Finance of America Companies Reports Significant Profit Turnaround Amidst Financial Restatement and Internal Control Weakness

Finance of America Companies Inc. has filed an amended quarterly report for Q3 2024, revealing a substantial improvement in net income and revenues from continuing operations, despite a restatement of prior financial statements due to cash flow classification errors and the identification of a material weakness in internal controls.

Summary

• Finance of America Companies Inc. (FOA) filed an amended Quarterly Report on Form 10-Q/A for the quarter ended September 30, 2024, to restate certain information from its original filing due to errors in cash flow classification related to nonrecourse securitization transactions.
• The restatement led to the identification of a material weakness in the company's internal control over financial reporting as of September 30, 2024.
• For the three months ended September 30, 2024, the company reported net income from continuing operations before income taxes of $208.17 million, a significant improvement from a net loss of $172.57 million in the comparable 2023 period.
• Total revenues for the three months ended September 30, 2024, were $290.07 million, compared to a negative revenue of $70.44 million in the prior year period.
• Net fair value changes on loans and related obligations improved by $369.0 million, primarily driven by market interest rate and yield volatility, resulting in net fair value gains in Q3 2024 compared to losses in Q3 2023.
• Total expenses decreased by $25.1 million, or 23.8%, for the three months ended September 30, 2024, primarily due to reduced headcount and cost-cutting measures.
• Reverse mortgage loan origination volume increased by 9.2% to $513.36 million for the three months ended September 30, 2024, with the weighted average margin on production increasing to 11.15% from 6.68% in 2023.
• The company's total assets increased to $28.95 billion as of September 30, 2024, from $27.11 billion at December 31, 2023, with total equity rising to $456.46 million from $272.41 million.
• Net cash used in operating activities significantly increased to $(317.61) million for the nine months ended September 30, 2024, compared to $(10.23) million in the prior year period, mainly due to the wind-down of non-core business lines.
• The company completed a 1-for-10 reverse stock split of its Class A Common Stock on July 25, 2024.
• As of September 30, 2024, the company was in compliance with all financial covenants related to its credit facilities, including Ginnie Mae requirements, having received a waiver for its minimum leverage ratio.

Sentiment

Score: 5

Explanation: While the company demonstrated a significant financial turnaround in net income and revenues from continuing operations, driven by strategic shifts and favorable market fair value changes, the restatement of financial statements and the identified material weakness in internal controls are serious concerns that undermine confidence in the reliability of financial reporting. The high-interest related-party debt and ongoing legal proceedings also present notable risks. The positive financial results are tempered by these significant operational and reporting issues.

Positives

• Net income from continuing operations before income taxes significantly improved to $208.17 million for Q3 2024, compared to a loss of $172.57 million in Q3 2023, and to $188.63 million for 9M 2024, compared to a loss of $338.40 million for 9M 2023.
• Total revenues saw a substantial turnaround, reaching $290.07 million in Q3 2024 from a negative $70.44 million in Q3 2023, and $443.79 million in 9M 2024 from a negative $41.48 million in 9M 2023.
• Net fair value changes on loans and related obligations improved significantly, contributing $228.18 million in Q3 2024 (vs. -$140.86 million in Q3 2023) and $249.25 million in 9M 2024 (vs. -$228.68 million in 9M 2023), primarily due to favorable market interest rate and yield volatility.
• Net origination gains increased to $57.22 million in Q3 2024 (from $31.38 million in Q3 2023) and $137.13 million in 9M 2024 (from $88.78 million in 9M 2023), driven by higher loan origination volumes and improved margins.
• The weighted average margin on reverse mortgage loan production increased to 11.15% in Q3 2024 from 6.68% in Q3 2023, and to 9.91% in 9M 2024 from 7.53% in 9M 2023.
• Total expenses decreased by 23.8% in Q3 2024 ($80.31 million) compared to Q3 2023 ($105.43 million), and by 14.2% in 9M 2024 ($256.67 million) compared to 9M 2023 ($299.21 million), reflecting successful cost-cutting measures and headcount reductions.
• The company's total equity increased to $456.46 million as of September 30, 2024, from $272.41 million at December 31, 2023.
• Net cash provided by financing activities significantly improved to $37.55 million for 9M 2024, compared to net cash used of $123.97 million for 9M 2023.
• The company was in compliance with all financial covenants related to its credit facilities and Ginnie Mae requirements as of September 30, 2024 (with a waiver for the leverage ratio).

Negatives

• The company's financial statements for the quarter ended September 30, 2024, required restatement due to errors in the classification and presentation of cash flows related to nonrecourse securitization transactions.
• A material weakness in the company's internal control over financial reporting was identified as of September 30, 2024, indicating a reasonable possibility of material misstatement not being prevented or detected.
• Net cash used in operating activities significantly increased to $317.61 million for the nine months ended September 30, 2024, compared to $10.23 million in the prior year, primarily due to the wind-down of non-core business lines.
• Net portfolio interest income decreased by $8.5 million in Q3 2024 compared to Q3 2023, primarily due to higher average cost of funds within the securitized financing portfolio.
• Fee income decreased by $5.1 million in Q3 2024 and $11.2 million in 9M 2024, mainly due to the wind-down of the home improvement lending business and lower MSR servicing fee income.
• Non-funding interest expense, net, increased by $1.9 million in Q3 2024 and $4.7 million in 9M 2024, due to increases in outstanding amounts and interest rates on working capital promissory notes.
• The company's actual ratio of tangible net worth to total assets was below the Ginnie Mae requirement, necessitating a waiver to remain in compliance.
• The company has outstanding Revolving Working Capital Promissory Notes with related parties accruing interest at a high rate of 15.0% per annum, with $84.6 million outstanding as of September 30, 2024.

Risks

• Ability to expand customer base and originate reverse mortgage loans efficiently while maintaining loan origination quality.
• Ability to finance and profitably securitize or monetize the reverse mortgage portfolio.
• Ability to realize anticipated benefits from the transition to a unified lending platform and streamline operations.
• Ability to respond to significant changes in prevailing interest rates and maintain profitable business operations.
• Geographic market concentration risk if economic conditions in current markets decline or are impacted by natural disasters.
• Ability to achieve anticipated returns from capital investments in technology.
• Reliance on estimates in measuring fair value of assets and liabilities, which may require write-downs or write-ups if estimates are incorrect.
• Ability to prevent cyber intrusions and mitigate cyber risks.
• Adverse effects from the condition of the U.S. residential mortgage market and other economic, political, business, and competitive factors, including sustained higher interest rates.
• Ability to manage changes in licensing status, business relationships, or servicing guidelines with governmental entities like Ginnie Mae and HUD.
• Ability to obtain sufficient capital and liquidity to meet financing and operational requirements and comply with debt agreements, including warehouse lending facilities, and pay down substantial debt.
• Ability to repay or refinance debt on reasonable terms as it becomes due.
• Ability to manage disruptions in the secondary home loan market, including the mortgage-backed securities market.
• Ability to finance and recover costs of reverse mortgage servicing operations.
• Ability to maintain compliance with extensive and complex regulations, including consumer protection laws.
• Competition with national banks not subject to state licensing and operational requirements.
• Management of various legal proceedings, federal or state governmental examinations, and enforcement investigations, with unpredictable or unestimable results.
• Continued ability to remain in compliance with consent orders issued by the Consumer Financial Protection Bureau.
• Holding company status and dependency on distributions from Finance of America Equity Capital LLC.
• Ability to comply with the continued listing standards of the New York Stock Exchange (NYSE).
• Low trading volume of common stock, potentially resulting in inability to sell shares at a desired price.
• Ability to remediate the material weakness in internal control over financial reporting and maintain an effective system of internal controls.
• Controlled company status under NYSE rules, which exempts the company from certain corporate governance requirements and affords stockholders fewer protections.

Future Outlook

The company's strategy and long-term growth initiatives are built upon growing its core retirement solutions business, benefiting from demographic and economic tailwinds, and seamlessly connecting borrowers with investors to efficiently and profitably monetize loans. The company plans for additional innovative products to satisfy the vast and largely underserved senior market. Management is actively monitoring economic events, including interest rate changes, and their potential effects on financial condition, liquidity, operations, industry, and workforce in 2024 and beyond. The company expects to renew existing warehouse facilities or obtain sufficient additional lines of credit as they mature.

Management Comments

• "The Company is actively monitoring these events and their effects on the Companys financial condition, liquidity, operations, industry, and workforce."
• "Management is committed to remediating the material weakness in a timely fashion."
• "Given the steps outlined above, management believes such efforts will effectively remediate the material weakness, however, these actions are subject to ongoing management evaluation, and the Company will need a period of execution to demonstrate remediation."
• "Management will continually assess the effectiveness of the remediation efforts and may determine to take additional measures to address control deficiencies or modify the remediation plan described above."
• "The Company is committed to the continuous improvement of its internal control over financial reporting and will continue to diligently review its internal control over financial reporting."

Industry Context

The company's performance is set against a backdrop of significant inflationary pressures and fluctuating interest rates. The U.S. Federal Reserve raised federal funds rates during the first three quarters of 2023, leading to lower mortgage transaction volumes, increased competition, and reduced profit margins. More recently, inflationary pressures have eased, and the Federal Reserve decreased the federal funds rate in September and November 2024. This volatility impacts credit spreads, credit availability, market liquidity, and asset fair values. The company's strategic shift to a 'modern retirement solutions platform' and focus on reverse mortgages aligns with demographic trends of an aging population seeking to utilize home equity.

Comparison to Industry Standards

• The document does not provide specific comparable companies, projects, or results to assess the company's performance against global benchmarks or industry standards.

Management Changes

Corporate Governance

Legal Proceedings

• The company is a defendant in three representative lawsuits alleging violations of the California Labor Code under the California Private Attorneys General Act (PAGA).
• Individual PAGA claims are subject to arbitration, with representative PAGA claims stayed pending resolution of individual claims and a California Supreme Court ruling.
• The outcome of these matters cannot be presently determined, and a range of possible losses cannot be reasonably estimated due to the unpredictable nature of litigation and wide discretion in awarding civil penalties.
• Legal expenses related to these matters were $0.7 million for the three months ended September 30, 2024, and $2.8 million for the nine months ended September 30, 2024.

Related Party Transactions

• The company has two Revolving Working Capital Promissory Note Agreements (Working Capital Promissory Notes) outstanding with BTO Urban Holdings L.L.C. and Libman Family Holdings, LLC, which are deemed affiliates.
• As of September 30, 2024, these notes had outstanding amounts of $84.6 million (compared to $59.1 million at December 31, 2023) and accrue interest monthly at a rate of 15.0% per annum, maturing in May 2025.
• Interest paid on these notes was $2.0 million for Q3 2024 and $4.8 million for 9M 2024.
• Related parties of FoA, including Blackstone and Brian L. Libman, purchased $135.0 million aggregate principal amount of the 2025 Unsecured Notes in November 2020.
• In October 2024, certain direct and indirect subsidiaries of the company completed an exchange of the 2025 Unsecured Notes with certain holders, including related parties, for new secured notes and cash.

Stakeholder Impact

• **Shareholders**: The restatement and material weakness could negatively impact investor confidence and potentially the share price. However, the significant improvement in net income and revenues from continuing operations could be viewed positively. The 1-for-10 reverse stock split aims to increase per-share price and potentially improve marketability.
• **Employees**: The reduction in average headcount and continued cost-cutting measures indicate potential job insecurity or increased workload for remaining employees, particularly in corporate services.
• **Customers**: The strategic shift to a 'modern retirement solutions platform' and focus on reverse mortgages aims to better serve senior homeowners, potentially offering more tailored financial solutions.
• **Creditors**: The company's compliance with financial covenants (albeit with a waiver for the Ginnie Mae leverage ratio) and the recent debt exchange for the 2025 Unsecured Notes indicate ongoing efforts to manage debt obligations and maintain access to financing, which is positive for creditors.
• **Regulatory Authorities**: The identified material weakness and restatement will likely lead to increased scrutiny from the SEC and other regulatory bodies, requiring significant remediation efforts and ongoing compliance monitoring.

Next Steps

• Remediate the identified material weakness in internal control over financial reporting by enhancing control documentation and providing additional training to accounting and financial reporting personnel.
• Continue to monitor economic events and their effects on the company's financial condition, liquidity, operations, industry, and workforce.
• Renew existing warehouse facilities or obtain sufficient additional lines of credit as they mature.
• Continue to manage and defend against ongoing legal proceedings, including PAGA lawsuits.

Key Dates

Recommendation

Keywords

Reverse Mortgage, SEC Filing, 10-Q/A, Financial Restatement, Internal Control Weakness, Mortgage Origination, Home Equity Conversion Mortgage (HECM), Nonrecourse Debt, Securitization, Financial Performance, Earnings, Revenue, Cash Flow, Liquidity, Capital Resources, Corporate Governance, Risk Management, Financial Services, Retirement Solutions, Portfolio Management, Interest Rates, Market Volatility, Sarbanes-Oxley Act, GAAP, Non-GAAP Metrics, AAG Transaction, Reverse Stock Split, Debt Exchange