Business Context and Reporting Period
This filing is a Form 10-Q for ZAIS Financial Corp. (not Ready Capital Corp.), covering the quarter ended March 31, 2015, filed May 11, 2015. The company originates, acquires, finances, sells, services and manages residential mortgage loans; invests in non-Agency RMBS and other real estate-related securities; and owns mortgage servicing rights. Following its October 2014 acquisition of GMFS, the company operated two segments: residential mortgage loan investments and residential mortgage banking.
The company elected REIT status and conducts substantially all operations through ZAIS Financial Partners, L.P. It had 7,970,886 common shares outstanding as of May 8, 2015.
Financial Results and Key Metrics
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Interest income | $9.7 million | $9.5 million |
| Interest expense | $4.7 million | $3.9 million |
| Net interest income | $4.9 million | $5.6 million |
| Non-interest income | $9.4 million | None reported |
| Total other gains/(losses) | $(1.9) million | $1.0 million |
| Total expenses | $12.2 million | $4.1 million |
| Net income | $0.4 million | $2.5 million |
| Net income attributable to common stockholders | $0.4 million | $2.2 million |
| Diluted EPS | $0.05 | $0.28 |
| Core Earnings, non-GAAP | $4.5 million | $1.5 million |
| Core Earnings per diluted share | $0.51 | $0.17 |
Mortgage banking activities contributed $11.2 million, including a $11.0 million net gain on mortgage loan sales and $0.4 million of origination fee income, partly offset by a $0.2 million loan indemnification provision. Net servicing fee income was $1.6 million. MSR fair-value changes reduced income by $3.4 million.
At March 31, 2015, total assets were $813.4 million, stockholders’ equity was $190.2 million, and book value per common share and OP unit was $21.38, compared with $21.73 at December 31, 2014. Cash was $38.0 million and restricted cash was $3.0 million.
The investment portfolio included mortgage loans held for investment at fair value of $411.1 million, mortgage loans held for sale of $126.0 million, RMBS of $145.7 million, other investment securities of $2.2 million and MSRs of $33.4 million. Mortgage loans held for sale increased from $97.7 million at year-end 2014, reflecting substantial GMFS origination activity.
Cash Flow, Debt and Liquidity
- Operating activities used $30.1 million of cash, compared with $1.7 million provided in Q1 2014, primarily because of mortgage loan originations, sales and MSR capitalization associated with the mortgage banking platform.
- Investing activities provided $14.0 million, compared with $102.1 million used in Q1 2014, primarily reflecting principal repayments and a reduction in restricted cash.
- Financing activities provided $20.3 million, compared with $73.5 million in Q1 2014.
- Cash increased by $4.2 million during the quarter to $38.0 million.
- Warehouse lines of credit totaled $116.9 million against $165.0 million of capacity, with a weighted average rate of 2.50%.
- Loan repurchase facilities totaled $299.8 million against $425.0 million of capacity, with a weighted average rate of 2.92%. Approximately $297.9 million matured within 31–60 days.
- Securities repurchase agreements totaled $99.6 million, principally secured by non-Agency RMBS, with borrowings generally maturing within 30 days.
- Exchangeable Senior Notes had $57.5 million of principal outstanding, bear interest at 8.0%, have an effective interest rate of 10.2%, and mature November 15, 2016.
- Total borrowings used to fund the investment portfolio and mortgage banking operations were approximately $573.6 million. The reported leverage ratio was 3.02x, compared with 2.84x at December 31, 2014.
- The company reported compliance with significant debt covenants and stated that it had met all margin-call requirements. It estimated a liquidity cushion of $40.6 million, excluding GMFS warehouse facilities, plus $3.0 million of restricted cash.
Material Changes Versus the Prior Comparable Period
- GMFS, acquired in October 2014, introduced the mortgage banking segment and materially increased loan originations, mortgage loans held for sale, servicing income, salaries and operating expenses.
- Mortgage loan originations for sale were $451.7 million and sales were $431.3 million in Q1 2015; the filing reports no comparable mortgage banking activity in Q1 2014.
- Net interest income declined $0.6 million as higher interest expense more than offset higher interest income. Interest income benefited from whole-loan growth and GMFS, but RMBS interest income declined by approximately $1.3 million.
- Expenses increased by $8.1 million, primarily from GMFS salaries, commissions, benefits and operating costs.
- GAAP net income declined from $2.5 million to $0.4 million, while Core Earnings increased from $1.5 million to $4.5 million because Core Earnings excludes certain fair-value, acquisition-related and other items.
- Net fair-value and derivative losses were $1.9 million versus a $1.0 million gain in Q1 2014. The primary negative items included a $1.2 million mortgage-loan valuation loss, a $0.2 million RMBS valuation loss and a $0.9 million investment-portfolio derivative loss.
- The company declared a quarterly dividend of $0.40 per common share, payable April 15, 2015.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal earnings or dividend guidance. Management described low interest rates, stable home-price appreciation and sustained mortgage origination volumes as supportive, while noting uncertainty regarding Federal Reserve policy and broader economic activity.
- The Citi loan repurchase facility, with approximately $297.9 million outstanding, was scheduled to mature May 22, 2015. Renewal discussions were ongoing, but renewal was not assured.
- A GMFS-related counterparty claim emerged in April 2015 under a statute-of-limitations tolling agreement concerning mortgage loans sold servicing released before the acquisition. Management could not reasonably estimate probable losses. The potential claims could result in substantial damages, litigation costs and losses exceeding existing reserves and contingent consideration.
- The GMFS acquisition generated contingent consideration of $12.0 million at March 31, 2015. The filing states that final consideration could differ materially from the estimate.
- The company recorded a $96,000 out-of-period adjustment to reverse unrealized gains on mortgage loans held for sale that had previously been sold; management concluded previously issued financial statements were not materially misstated.
- Interest-rate, prepayment, credit, fair-value, counterparty and extension risks are significant. A hypothetical 50-basis-point increase in LIBOR would increase quarterly interest expense on variable-rate debt by approximately $0.6 million, before considering other economic effects.
- More than half of the fair value of the mortgage loan portfolio was secured by properties with loan-to-property-value ratios above 100%. California and Florida represented 26.6% and 16.1%, respectively, of mortgage-loan fair value.
- The company depends on its external advisor and on continued access to warehouse lines and repurchase facilities. REIT qualification also requires substantial annual distributions, limiting retained capital.
Most Important Facts for Investors to Verify
- Confirm that the filing relates to ZAIS Financial Corp., despite the request identifying Ready Capital Corp.
- Verify renewal or replacement of the Citi loan repurchase facility and other short-term financing arrangements.
- Assess the magnitude and probability of the GMFS counterparty claim and whether reserves or contingent consideration are adequate.
- Reconcile GAAP net income of $0.4 million with non-GAAP Core Earnings of $4.5 million and evaluate the sustainability of mortgage banking earnings.
- Monitor leverage, margin requirements, collateral haircuts, liquidity cushion and exposure to variable-rate borrowings.
- Evaluate MSR valuation sensitivity to prepayment speeds, discount rates and servicing costs.
- Review the company’s ability to maintain REIT qualification and fund required distributions while supporting growth and debt maturities.