Business Context and Reporting Period
The filing is ZAIS Financial Corp.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2013. The requested company name is Ready Capital Corp., but the filing identifies the registrant as ZAIS Financial Corp.; this identity should be verified.
The company operated as a REIT, externally managed by ZAIS REIT Management, LLC, and invested primarily in Agency and non-Agency residential mortgage-backed securities (RMBS) and performing or re-performing residential mortgage loans. It completed its initial public offering (IPO) on February 13, 2013, raising $118.9 million in net proceeds.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2013 | Three Months Ended June 30, 2012 | Six Months Ended June 30, 2013 | Six Months Ended June 30, 2012 |
|---|---|---|---|---|
| Interest income | $5.9 million | $2.3 million | $9.4 million | $5.0 million |
| Interest expense | $1.2 million | $0.4 million | $1.7 million | $0.7 million |
| Net interest income | $4.8 million | $1.9 million | $7.7 million | $4.4 million |
| Net income/(loss) | $(7.6) million | $3.3 million | $(5.6) million | $9.6 million |
| Net income/(loss) attributable to common stockholders | $(6.8) million | $3.3 million | $(5.1) million | $9.6 million |
| Basic and diluted EPS | $(0.85) | $1.10 | $(0.78) | $3.16 |
| Core Earnings, non-GAAP | $3.0 million | $1.2 million | $3.8 million | $2.9 million |
The filing does not provide a conventional consolidated operating margin. Net interest income represented approximately 80.5% of interest income in the second quarter and 82.2% for the six-month period.
Balance Sheet, Portfolio and Liquidity
- Total assets were $607.9 million at June 30, 2013, compared with $201.6 million at December 31, 2012.
- RMBS at fair value were $444.5 million, including $174.5 million of Agency RMBS and $270.0 million of non-Agency RMBS.
- Mortgage loans at fair value were $120.8 million, against a $151.1 million unpaid principal balance. Four loans with a fair value of $358,000 and principal balance of $555,000 were on non-accrual status.
- Cash was $21.2 million and restricted cash was $12.5 million. Operating activities generated $3.5 million of cash during the first six months.
- Borrowings consisted of $308.5 million under RMBS repurchase agreements and $89.1 million under a mortgage-loan repurchase facility, for approximately $397.6 million of total borrowings.
- The effective leverage ratio was 2.55x, including Agency RMBS exposure through TBA contracts. Management reported an $86.8 million liquidity cushion and stated that identified sources were expected to cover short-term needs, although additional financing may be required for longer-term needs.
- Stockholders’ equity was $177.5 million, compared with $65.1 million at year-end 2012. Common shares outstanding increased to 7,970,886 from 2,071,096.
Material Changes Versus Prior Comparable Period
- The portfolio expanded substantially following the IPO and new financing activity. RMBS fair value increased from $170.7 million at December 31, 2012 to $444.5 million at June 30, 2013, and mortgage loans were added at $120.8 million.
- Interest income and net interest income increased materially because of the larger RMBS portfolio and the addition of mortgage loans, but interest expense also increased with higher borrowings.
- GAAP results declined sharply because of fair-value losses. The company recorded a $15.6 million unrealized RMBS loss in the second quarter and a $14.7 million loss for the first six months, compared with gains of $2.9 million and $9.4 million, respectively, in the prior-year periods.
- Derivative results improved to a $3.7 million gain in the second quarter and a $4.0 million gain for the first six months, compared with losses in the prior-year periods. This partly offset RMBS fair-value losses.
- Expenses increased following the IPO and public-company transition. Six-month advisory fees rose to $1.2 million from $0.5 million, professional fees to $1.5 million from $0.9 million, and general and administrative expenses to $1.1 million from $0.1 million.
- The company initiated its mortgage-loan financing platform in May 2013 through a committed $150 million portion of a facility with aggregate borrowing capacity of up to $250 million; $89.1 million was outstanding at quarter-end.
Guidance, Outlook, Commentary and Risks
Management did not provide numerical earnings guidance. It stated that the IPO proceeds had been fully deployed, but the company was not yet fully invested in its long-term target assets or fully leveraged; therefore, second-quarter results were not necessarily indicative of expected results after reaching its planned investment and leverage levels.
The stated long-term allocation ranges were approximately 50% to 60% of equity to mortgage loans, 30% to 40% to non-Agency RMBS, 5% to 10% to mortgage servicing rights and other assets or cash, and 0% to 5% to Agency RMBS.
- Management attributed second-quarter market losses to Federal Reserve communications, rising interest rates, increased volatility and wider Agency and non-Agency RMBS spreads.
- Key risks include interest-rate movements, widening spreads, fair-value volatility, prepayment and extension risk, defaults and delinquencies in mortgage loans and non-Agency RMBS, and changes in home prices.
- Repurchase financing is generally short-term and renewable at lenders’ discretion. Declines in collateral values may trigger margin calls, additional collateral requirements or forced asset sales. The company had met all margin calls through June 30, 2013.
- Interest-rate swaps with $225.7 million of notional value were used to mitigate exposure to higher short-term rates. Management estimated that a 50-basis-point increase in LIBOR would increase quarterly interest expense on unhedged variable-rate debt by approximately $0.2 million, assuming no structural changes.
- The company relies on its external Advisor and has no employees. It must distribute at least 90% of annual REIT taxable income to maintain REIT status, limiting retained capital. Loss of REIT qualification could materially increase taxes and reduce distributions.
- The company reported no material legal proceedings, no material changes to previously disclosed risk factors, and no off-balance-sheet arrangements. Disclosure controls were deemed effective.
- On July 25, 2013, after quarter-end, the company used approximately $98.7 million of the loan repurchase facility to fund part of a mortgage-loan portfolio acquisition with an unpaid principal balance of approximately $167.8 million.
Most Important Facts for Investors to Verify
- Confirm whether the filing belongs to ZAIS Financial Corp. or Ready Capital Corp.; the submitted filing is clearly headed ZAIS Financial Corp.
- Reconcile the substantial increase in assets, equity, leverage and share count with the February 2013 IPO and related financing transactions.
- Assess the sustainability of recurring Core Earnings of $3.0 million in the quarter against the $(7.6) million GAAP loss and the company’s fair-value accounting exposure.
- Review the valuation assumptions and market sensitivity of the $270.0 million Level 3 non-Agency RMBS portfolio and $120.8 million Level 3 mortgage-loan portfolio.
- Evaluate collateral haircuts, borrowing maturities, lender renewal risk and potential margin calls on approximately $397.6 million of financing.
- Review the post-quarter-end mortgage-loan acquisition and associated $98.7 million financing utilization.
- Verify dividend capacity under REIT distribution requirements, particularly given the first-half GAAP loss and the company’s reliance on taxable rather than GAAP earnings for distributions.