Business Context and Reporting Period
This unaudited Form 10-Q is for the three months ended March 31, 2014, filed May 13, 2014, by ZAIS Financial Corp. (the filing entity identified in the source, rather than Ready Capital Corp.). The company is an externally managed mortgage REIT that invests in performing and re-performing residential mortgage loans, non-Agency RMBS and other real estate-related securities. It conducts substantially all operations through ZAIS Financial Partners, L.P. and is managed by ZAIS REIT Management, LLC.
The company held 7,970,886 common shares outstanding as of May 12, 2014, and owned approximately 89.6% of the operating partnership. It elected REIT status beginning in 2011.
Financial Metrics
| Metric | Q1 2014 / March 31, 2014 | Comparable period / December 31, 2013 |
|---|---|---|
| Total assets | $698.2 million | $620.1 million |
| Cash and restricted cash | $35.9 million | $59.2 million |
| Mortgage loans at fair value | $415.6 million | $331.8 million |
| Real estate securities at fair value | $231.8 million | $226.2 million |
| Other investment securities | $11.1 million | None reported |
| Total liabilities | $521.5 million | $442.3 million |
| Total stockholders’ equity | $176.7 million | $177.8 million |
| Net interest income | $5.6 million | $2.9 million |
| Net income | $2.5 million | $2.0 million |
| Net income attributable to common stockholders | $2.2 million | $1.7 million |
| Basic and diluted EPS | $0.28 | $0.32 |
| Core Earnings, non-GAAP | $1.5 million, or $0.17 per share | $0.8 million, or $0.13 per share |
| Book value per common share and OP unit | $19.86 | $19.98 |
| Leverage ratio | 2.90x | Comparable prior-period leverage not clearly provided |
| Net cash from operating activities | $1.7 million | $0.1 million |
Interest income was $9.5 million and interest expense was $3.9 million. The weighted-average net interest spread, including hedging effects, was 3.97% for mortgage loans and 4.82% for non-Agency RMBS and other investment securities.
Operating expenses were $4.1 million, including $1.8 million of professional fees, $0.7 million of related-party advisory fees, $0.4 million of loan servicing fees and $1.2 million of general and administrative expenses.
Cash used in investing activities was $102.1 million, primarily for mortgage loan, RMBS and other security acquisitions and a $4.8 million swaption premium. Cash provided by financing activities was $73.5 million. Cash declined by $27.0 million during the quarter to $30.1 million.
Material Changes Versus Prior Comparable Period
- Mortgage loan fair value increased by $83.8 million from year-end 2013, primarily reflecting a March 2014 acquisition with approximately $100.4 million of unpaid principal balance.
- Interest income increased by $6.1 million, primarily from deployment of capital raised through the 2013 IPO and Exchangeable Senior Notes issuance into whole loans.
- Interest expense increased by $3.4 million because of substantially higher repurchase borrowings and the 8% Exchangeable Senior Notes issued in November 2013.
- Net income increased by $0.5 million, but basic EPS declined from $0.32 to $0.28 because the share base was larger following the IPO.
- Core Earnings increased from $0.8 million to $1.5 million, or from $0.13 to $0.17 per share.
- Other gains and losses included a $3.1 million net loss on derivatives in Q1 2014, compared with a $0.3 million gain in Q1 2013. This largely reflected losses on a newly entered interest rate swaption.
- General and administrative expenses increased by $0.9 million, primarily due to due diligence and professional costs related to evaluating a potential acquisition.
- The company acquired $10.0 million principal amount of Fannie Mae Risk Transfer Notes, reported at a fair value of $11.1 million, and acquired $14.5 million principal amount of non-Agency RMBS.
- The company declared a $0.40 per-share dividend for the quarter, payable April 14, 2014. Dividends and distributions paid during the quarter totaled $8.5 million.
Debt, Liquidity, Outlook and Risks
Borrowings used to finance the portfolio totaled approximately $512.9 million, consisting of $297.4 million under the Loan Repurchase Facility, $159.2 million under securities repurchase agreements and $57.5 million principal amount of Exchangeable Senior Notes due November 2016. The Loan Repurchase Facility had a $325.0 million total borrowing capacity after a March 27, 2014 amendment, including $75 million of additional uncommitted capacity.
The initial 364-day Loan Repurchase Facility was approaching expiration. Management stated that it expected to renew the facility for another 364-day period, but renewal remained subject to definitive agreements and was not assured. Repurchase agreements were generally short-term and renewable at lenders’ discretion.
The company reported $55.2 million of liquidity cushion and $5.9 million of restricted cash. It had satisfied all margin calls through March 31, 2014 and stated that it had never sold assets in response to a margin call. However, declines in collateral values, higher haircuts, increased interest rates or faster prepayments could create additional collateral requirements and pressure liquidity.
Management intended to expand over time into newly originated residential mortgage loans but had not yet begun originating or purchasing newly originated loans. Management believed existing liquidity was adequate for short-term and long-term needs, while acknowledging that additional financing might be required.
- Key market risks include interest-rate, prepayment, credit, extension, fair-value and counterparty risk.
- A hypothetical 50-basis-point increase in LIBOR was estimated to increase quarterly interest expense on variable-rate debt by approximately $0.5 million, before considering other economic or hedging actions.
- The portfolio was concentrated in Level 3 fair-value assets, including $415.6 million of mortgage loans and $231.8 million of non-Agency RMBS, making reported earnings sensitive to model assumptions and market liquidity.
- Mortgage loan fair value was $80.4 million below unpaid principal balance; 5.3% of mortgage loan fair value was non-performing, based on the company’s definition of loans delinquent 60 days or more.
- Mortgage loan exposure was concentrated in California and Florida, which represented 25.2% and 16.4% of mortgage loan fair value, respectively.
- The company depended on its external Advisor for investment selection, valuation, financing and daily operations. Termination without cause could trigger a termination fee.
- Maintaining REIT status requires annual distribution of at least 90% of taxable income. Failure to qualify could materially increase taxes and reduce distributions.
- No material litigation, off-balance-sheet arrangements or subsequent events were reported. Management stated that disclosure controls were effective and that there were no material changes in internal controls.
Important Facts for Investors to Verify
- Confirm that the intended issuer is ZAIS Financial Corp.; the supplied metadata identifies Ready Capital Corp., but the filing text identifies ZAIS Financial Corp.
- Monitor renewal or replacement of the Loan Repurchase Facility and the availability and terms of other short-term repurchase financing.
- Reconcile reported Core Earnings with GAAP net income and assess the volatility from fair-value changes and derivative losses.
- Review collateral haircuts, margin-call requirements, restricted cash and the $55.2 million liquidity cushion under stressed market conditions.
- Assess the valuation sensitivity of Level 3 mortgage loans and non-Agency RMBS to defaults, prepayments, loss severity, home prices and market liquidity.
- Evaluate the sustainability of dividends relative to taxable income, Core Earnings, leverage and required REIT distributions.
- Review the 8% Exchangeable Senior Notes, including the November 2016 maturity, exchange terms, derivative liability and potential cash or equity settlement.