10-Q/A: Finance of America Restates Q2 2024 Financials, Citing Cash Flow Classification Errors and Material Weakness in Internal Controls

Finance of America Companies Inc. has filed an amended quarterly report for June 30, 2024, to correct errors in cash flow classification and disclose a material weakness in its internal control over financial reporting, despite reporting a significant reduction in net loss.

Summary

• Finance of America Companies Inc. (FOA) filed an amended Quarterly Report on Form 10-Q/A for the quarter ended June 30, 2024, to restate previously issued financial statements.
• The restatement addresses errors in the classification and presentation of amounts related to nonrecourse securitization transactions in the Condensed Consolidated Statements of Cash Flows.
• Specifically, 'Call and Reissue Transactions' were incorrectly reported on a net basis instead of a gross basis, and certain cash activity was misclassified between investing and financing activities.
• Management identified a material weakness in the company's internal control over financial reporting and concluded that its internal control over financial reporting and disclosure controls and procedures were ineffective for the quarter ended June 30, 2024.
• Despite the control issues, the company reported a significant reduction in net loss from continuing operations before income taxes, decreasing from $(223.8) million in Q2 2023 to $(3.8) million in Q2 2024.
• Total revenues from continuing operations improved substantially, moving from a loss of $(111.9) million in Q2 2023 to a gain of $79.0 million in Q2 2024, primarily driven by improved fair value changes on loans and related obligations.
• For the six months ended June 30, 2024, net loss from continuing operations before taxes decreased to $(19.5) million from $(165.8) million in the comparable 2023 period.
• Total expenses decreased by $25.0 million (22.7%) in Q2 2024 compared to Q2 2023, mainly due to reduced headcount and cost-cutting measures.
• The company's business transformation to a 'modern retirement solutions platform' focusing on home equity-based financing (reverse mortgages) is ongoing, following the wind-down of other business lines and the acquisition of American Advisors Group (AAG) assets in March 2023.
• As of June 30, 2024, total debt obligations were approximately $27.5 billion, with HMBS related obligations at $18.0 billion and nonrecourse debt at $8.1 billion.
• The company was in compliance with all financial covenants as of June 30, 2024, including Ginnie Mae requirements, having received a waiver for its leverage ratio.

Sentiment

Score: 4

Explanation: While the company showed significant financial improvement in reducing net loss and increasing revenues, the disclosure of a material weakness in internal controls and the need for a restatement are serious negative indicators regarding financial reporting reliability. The debt restructuring is a necessary step but highlights ongoing financial management challenges. The positive financial performance is overshadowed by governance and control issues.

Positives

• Net loss from continuing operations before income taxes significantly decreased to $(3.8) million in Q2 2024 from $(223.8) million in Q2 2023, representing a 98.3% improvement.
• Total revenues from continuing operations dramatically improved to $79.0 million in Q2 2024 from $(111.9) million in Q2 2023.
• Net fair value changes on loans and related obligations improved by $193.9 million, contributing significantly to revenue growth.
• Net origination gains increased to $40.3 million in Q2 2024 from $32.9 million in Q2 2023, driven by higher reverse mortgage loan origination volumes ($446.6 million vs $397.6 million) and higher margins (9.02% vs 8.28%).
• Total expenses decreased by $25.0 million (22.7%) in Q2 2024 compared to Q2 2023, reflecting a reduction in average headcount and ongoing cost-cutting measures.
• The company successfully completed a 1-for-10 reverse stock split on July 25, 2024, which can improve per-share metrics and market perception.
• The company was in compliance with all financial covenants, including Ginnie Mae requirements, as of June 30, 2024, demonstrating financial stability despite the restatement.

Negatives

• The company identified a material weakness in its internal control over financial reporting and concluded that disclosure controls and procedures were ineffective for the quarter ended June 30, 2024.
• The filing is an amendment to correct errors in cash flow classification and presentation, indicating past inaccuracies in financial reporting.
• Net cash provided by (used in) operating activities decreased significantly to $(236.2) million for the six months ended June 30, 2024, compared to $115.7 million in the comparable 2023 period.
• Fee income decreased by $5.9 million in Q2 2024 due to the wind-down of the home improvement lending business and lower mortgage servicing rights (MSR) fee income.
• The company's actual ratio of tangible net worth to total assets was below the Ginnie Mae requirement, necessitating a waiver, indicating a potential capital constraint or balance sheet structure issue.

Risks

• The company's ability to expand its customer base, originate reverse mortgage loans efficiently, finance its portfolio, and profitably securitize or monetize its portfolio depends on managing unique challenges as a unified modern retirement solutions platform.
• The ability to realize anticipated benefits from transitioning to a unified lending platform and streamlining operations is crucial for profitable business.
• Significant changes in prevailing interest rates can adversely affect loan origination volume and profitability.
• Geographic market concentration poses a risk if economic conditions in current markets decline or are impacted by natural disasters.
• Reliance on estimates for fair value of assets and liabilities may lead to write-downs or write-ups if estimates are incorrect.
• Cyber intrusions and cyber risks pose a threat to the company's operations.
• Adverse conditions in the U.S. residential mortgage market and broader economic, political, business, and competitive factors, including sustained higher interest rates, can negatively impact the company.
• Changes in licensing status, business relationships, or servicing guidelines with governmental entities like Ginnie Mae or HUD could affect operations.
• The ability to obtain sufficient capital and liquidity, comply with debt agreements, and repay/refinance substantial debt on reasonable terms is critical.
• Disruptions in the secondary home loan market, including the mortgage-backed securities market, could impact the business.
• The company's ability to finance and recover costs of its reverse mortgage servicing operations is a risk.
• Maintaining compliance with extensive and complex regulations, including consumer protection laws, is a continuous challenge.
• Competition with national banks, which are not subject to state licensing and operational requirements, is a risk.
• The company is subject to various legal proceedings, federal or state governmental examinations, and enforcement investigations, with unpredictable outcomes and potential for fines, penalties, or business practice alterations.
• Continued compliance with consent orders issued by the Consumer Financial Protection Bureau, assumed from the AAG acquisition, is required.
• As a holding company, dependency on distributions from Finance of America Equity Capital LLC is a risk.
• The company must comply with the continued listing standards of the New York Stock Exchange (NYSE).
• Low trading volume of common stock may result in inability to sell shares at a desired price.
• Failure to remediate the identified material weakness in internal control over financial reporting could adversely affect the ability to record, process, summarize, and report financial information.
• Controlled company status under NYSE rules exempts the company from certain corporate governance requirements, affording stockholders fewer protections.

Future Outlook

The company is focused on growing its core retirement solutions businesses, leveraging demographic and economic tailwinds to help senior homeowners utilize home equity. It aims to seamlessly connect borrowers with investors, programmatically and profitably monetize loans to minimize capital at risk, and potentially retain future performance-based participation interests. The company plans for additional innovative non-agency reverse mortgage loan products to serve the underserved senior market. Management is committed to remediating the identified material weakness in internal control over financial reporting through enhanced control documentation and additional training for personnel.

Management Comments

• "Finance of America Companies Inc. (we, us, our, FOA, or the Company) is filing this Amendment No. 1 to our Quarterly Report on Form 10-Q/A... to amend and restate certain information included in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2024..."
• "...errors were identified in the classification and presentation of amounts associated with certain nonrecourse securitization transactions in the Company’s Condensed Consolidated Statements of Cash Flows and the related disclosures..."
• "...the Company incorrectly reported the cash flows related to these Call and Reissue Transactions on a net basis within the Condensed Consolidated Statements of Cash Flows rather than on a gross basis."
• "As a result of the information described above, the Company’s management has identified a material weakness in the Company’s internal control over financial reporting and concluded that its internal control over financial reporting and disclosure controls and procedures were ineffective for the quarter ended June 30, 2024."
• "Notwithstanding this material weakness, based on the additional analysis and other post-closing procedures performed, the Company believes the interim unaudited condensed consolidated financial statements and other financial information included in this Amended 10-Q, are fairly presented, in all material respects, in conformity with GAAP."
• "Management is committed to remediating the material weakness in a timely fashion."
• "Our strategy and long-term growth initiatives are built upon a few key fundamental factors: We are focused on growing our core retirement solutions businesses... We seamlessly connect borrowers with investors... We distribute our products through multiple channels..."
• "Management continually monitors these costs through operating plans."
• "Upon expiration, management believes it will either renew its existing facilities or obtain sufficient additional lines of credit."

Industry Context

Finance of America is actively transforming its business to focus on home equity-based financing solutions for modern retirement, specifically reverse mortgages. This strategic shift aligns with demographic trends of an aging population seeking to leverage home equity for retirement goals. The company's emphasis on securitization and capital markets capabilities positions it to manage liquidity and distribute loans efficiently in a volatile interest rate environment. The industry faces challenges from sustained higher interest rates, which can impact loan origination volumes and the fair value of financial assets, as well as increased competition. The company's acquisition of AAG assets in March 2023 indicates a move towards consolidating market share in the reverse mortgage sector.

Comparison to Industry Standards

• The document does not provide specific comparisons to industry-wide benchmarks or named competitors' projects/results.
• The company states it is a 'leader in this market' (reverse mortgage), implying a strong competitive position, but no specific market share data or peer performance metrics are provided for direct comparison.
• The company's ability to complete several issuances and sales of mortgage-backed securities in 2023 and H1 2024 demonstrates the 'high quality and liquidity of the loan products we originate, the deep relationships we have with our investors, and the resilience of our business model in many economic environments,' suggesting performance in line with or exceeding market expectations for securitization activity.

Corporate Governance

Legal Proceedings

• The company is a defendant in three representative lawsuits alleging violations of the California Labor Code, brought pursuant to the California Private Attorneys General Act (PAGA).
• Individual PAGA claims must be arbitrated, and representative PAGA claims are stayed pending resolution of individual claims.
• 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 $1.8 million for Q2 2024 and $2.1 million for the six months ended June 30, 2024.

Related Party Transactions

• The company has two Revolving Working Capital Promissory Note Agreements outstanding with BTO Urban Holdings L.L.C. and Libman Family Holdings, LLC (deemed affiliates).
• Outstanding amounts under these notes were $84.6 million as of June 30, 2024, accruing interest monthly at 15.0% per annum and maturing in May 2025.
• Interest paid on these notes was $1.6 million for Q2 2024 and $2.8 million for the six months ended June 30, 2024.
• Related parties (Blackstone and Brian L. Libman) purchased $135.0 million aggregate principal amount of the company's senior unsecured notes in November 2020.

Stakeholder Impact

• **Shareholders**: The restatement and material weakness could negatively impact investor confidence and share price. The 1-for-10 reverse stock split aims to improve per-share metrics but doesn't change underlying value. The debt exchange could impact future debt servicing costs and capital structure.
• **Employees**: Continued cost-cutting measures and reduction in average headcount (e.g., 38.8% decline in average onshore headcount in Corporate and Other) indicate ongoing workforce adjustments.
• **Customers**: The company's focus on 'modern retirement solutions' and expansion of reverse mortgage products aims to better serve senior homeowners. The AAG acquisition expands its customer base.
• **Creditors**: The company's compliance with financial covenants and efforts to restructure debt (exchange of notes) are positive for creditors, but the material weakness in financial reporting could raise concerns about transparency and risk management.
• **Regulatory Bodies**: The identified material weakness and restatement will likely lead to increased scrutiny from the SEC and other regulatory bodies, requiring significant remediation efforts.

Next Steps

• Management is committed to remediating the material weakness in internal control over financial reporting.
• Remediation plan includes enhancing control documentation and providing additional training to accounting and financial reporting personnel.
• The company will continually assess the effectiveness of remediation efforts and may take additional measures.
• The company is concurrently filing an amendment to its Quarterly Report on Form 10-Q for the quarter ended September 30, 2024.
• The company's senior unsecured notes are subject to an exchange agreement for new secured and exchangeable notes, with details to follow as the exchange progresses.

Key Dates

Recommendation

Keywords

Reverse Mortgage, Home Equity Conversion Mortgage, HECM, Mortgage-Backed Securities, HMBS, SEC Filing, 10-Q/A, Financial Restatement, Internal Controls, Material Weakness, Financial Services, Lending, Portfolio Management, Liquidity, Capital Resources, Debt Restructuring, Sarbanes-Oxley Act, Ginnie Mae, HUD, Fair Value Accounting, Financial Reporting