Business Context and Reporting Period
This summary covers ZAIS Financial Corp.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2014. The request identifies Ready Capital Corp., but the filing is for ZAIS Financial Corp.; the entity name should be verified. ZAIS was an externally managed REIT investing primarily in performing and re-performing residential mortgage loans, non-Agency RMBS and other real estate-related securities.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2014 | Six Months Ended June 30, 2014 |
|---|---|---|
| Interest income | $10.8 million | $20.3 million |
| Interest expense | $4.4 million | $8.3 million |
| Net interest income | $6.4 million | $12.0 million |
| Net income | $25.9 million | $28.4 million |
| Net income attributable to common stockholders | $23.2 million | $25.4 million |
| Diluted EPS | $2.47 | $2.79 |
| Core Earnings, non-GAAP | $3.2 million, or $0.36 per diluted share | $4.7 million, or $0.53 per diluted share |
- Total assets were $713.2 million at June 30, 2014, up from $620.1 million at December 31, 2013.
- Mortgage loans at fair value were $433.6 million; non-Agency RMBS were $227.3 million; and other investment securities were $12.0 million.
- Total liabilities were $514.2 million and total stockholders’ equity was $199.0 million. Book value was $22.37 per common share and OP unit, compared with $19.86 at March 31, 2014.
- Borrowings included $293.6 million under the loan repurchase facility, $156.3 million under securities repurchase agreements and $57.5 million principal amount of 8% Exchangeable Senior Notes due 2016. Management reported a 2.54x leverage ratio.
- Cash was $27.6 million and restricted cash was $8.1 million at quarter-end. The reported liquidity cushion was $51.6 million. The filing states that all margin calls had been satisfied.
- Net cash used in operating activities was $1.8 million for the six months. Investing activities used $91.0 million, while financing activities provided $63.3 million, producing a $29.4 million decrease in cash.
- The filing does not provide a consolidated revenue or operating margin measure beyond interest income, net interest income and reported earnings.
Material Changes Versus Prior Comparable Period
- Second-quarter net income improved from a $7.6 million loss in 2013 to $25.9 million of income in 2014. Six-month net income improved from a $5.6 million loss to $28.4 million of income.
- Net interest income increased from $4.8 million to $6.4 million in the second quarter and from $7.7 million to $12.0 million for the six months, primarily because capital from the 2013 IPO and Exchangeable Senior Notes was deployed into whole loans.
- Interest expense increased substantially because of higher repurchase borrowings and the issuance of the Exchangeable Senior Notes.
- Unrealized gains on mortgage loans increased to $22.0 million in the quarter and $22.7 million year to date, compared with $1.6 million in each prior comparable period.
- Real estate securities generated unrealized gains of $1.5 million in the quarter and $4.3 million year to date, compared with prior-period unrealized losses of $15.6 million and $14.7 million, respectively.
- Derivative results changed from a $3.7 million gain in the second quarter of 2013 to a $1.9 million loss in 2014, and from a $4.0 million gain to a $5.0 million loss year to date.
- Professional fees, loan servicing fees and general and administrative expenses increased, partly because of whole-loan expansion, financing structures and diligence related to the proposed GMFS acquisition.
Guidance, Outlook, Risks and Unusual Items
- Management intended to expand into newly originated residential mortgage loans during the second half of 2014 through the proposed GMFS platform and an independent loan-seller network.
- On August 5, 2014, the Company agreed to acquire GMFS, subject to closing conditions, for estimated cash consideration of approximately $61 million, two potential $1 million deferred payments and contingent consideration capped at $20 million. Closing was expected in the fourth quarter of 2014. Management planned to fund the transaction with existing cash and sales of non-Agency RMBS.
- On August 11, 2014, the investment advisory agreement was amended to provide the Advisor a quarterly loan-sourcing fee equal to 0.50% of newly originated residential mortgage loans sourced through its conduit program and acquired by Company subsidiaries.
- The loan repurchase facility was amended to provide an additional $75.0 million of uncommitted capacity and was extended through May 22, 2015. Total capacity was $325.0 million, with $31.4 million unused at June 30, 2014.
- Material risks include interest-rate movements, LIBOR-based funding costs, margin calls, refinancing and counterparty risk, prepayment and extension risk, credit losses, fair-value volatility and reliance on the external Advisor.
- Most portfolio assets were valued using Level 3 inputs. Mortgage loan and non-Agency RMBS valuations were sensitive to prepayment, default, delinquency, loss-severity and home-price assumptions.
- The Company was required to distribute at least 90% of annual REIT taxable income and could lose REIT status if applicable requirements were not satisfied.
- No material legal proceedings, off-balance-sheet arrangements or material changes to previously disclosed risk factors were reported.
Investor Verification Items
- Confirm whether the intended issuer is ZAIS Financial Corp. or Ready Capital Corp.
- Reconcile GAAP earnings with Core Earnings and assess how much reported profit depended on unrealized fair-value gains.
- Review collateral haircuts, borrowing maturities, unused facility capacity and potential margin-call requirements.
- Evaluate the proposed GMFS purchase price, funding plan, regulatory approvals, contingent consideration and integration risks.
- Assess the sensitivity of book value and earnings to interest rates, prepayments, defaults and Level 3 valuation assumptions.
- Verify the sustainability of dividends relative to taxable income, cash flow and leverage.