Business Context and Reporting Period
Registrant: ZAIS Financial Corp. (the source filing does not identify Ready Capital Corp.); Form 10-Q for the quarter and six months ended June 30, 2016. The company operated as a REIT through two segments: residential mortgage investments and residential mortgage banking, including GMFS, LLC.
The company invested in residential mortgage loans, non-Agency RMBS, other mortgage-related securities and mortgage servicing rights (MSRs), while GMFS originated, sold and serviced residential mortgage loans. GMFS had 242 employees at June 30, 2016.
Financial Metrics
| Metric | Three Months Ended June 30, 2016 | Six Months Ended June 30, 2016 |
|---|---|---|
| Total interest income | $5.2 million | $13.9 million |
| Net interest income | $1.1 million | $5.0 million |
| Mortgage banking activities, net | $15.6 million | $27.2 million |
| Change in MSR fair value | $(6.2) million | $(14.2) million |
| Total expenses | $16.1 million | $30.5 million |
| Net income/(loss) | $(1.1) million | $(4.5) million |
| Loss attributable to common stockholders | $(1.0) million | $(4.1) million |
| Basic loss per share | $(0.13) | $(0.51) |
| Core Earnings, non-GAAP | $(1.0) million | $0.8 million |
- Cash and cash equivalents were $188.5 million at June 30, 2016, compared with $20.8 million at December 31, 2015. Restricted cash was $4.8 million.
- Total assets were $565.4 million, down from $775.1 million at year-end 2015. Total equity was $166.2 million, down from $177.8 million.
- Book value per common share and OP unit was $18.66, compared with $19.98 at December 31, 2015. Reported leverage was 1.94x versus 2.97x.
- Major assets included $43.6 million of mortgage loans held for investment, $113.9 million of mortgage loans held for sale, $84.6 million of non-Agency RMBS, $13.2 million of other investment securities and $44.5 million of MSRs.
- Debt and financing liabilities included $102.5 million of warehouse lines, $69.3 million of Treasury securities repurchase agreements, $34.0 million of loan repurchase facilities, $58.7 million of securities repurchase agreements and $57.1 million carrying value of Exchangeable Senior Notes.
- Cash flow from operating activities was an outflow of $0.1 million. Investing activities provided $381.3 million, primarily reflecting mortgage loan sale proceeds. Financing activities used $213.5 million, including $7.1 million of dividends and OP-unit distributions.
Material Changes Versus Prior Comparable Period
- GAAP results declined from net income of $6.7 million in the second quarter of 2015 and $7.1 million for the first six months of 2015 to losses of $1.1 million and $4.5 million, respectively, in 2016.
- Net interest income fell from $4.8 million to $1.1 million in the quarter and from $9.8 million to $5.0 million for the six-month period. The principal driver was the sale of the seasoned, re-performing loan portfolio.
- Non-interest income declined to $11.5 million from $17.4 million in the quarter and to $17.1 million from $26.8 million for the six-month period, primarily because MSR fair value declined by $6.2 million in the quarter and $14.2 million year to date, versus gains in the prior-year periods.
- Mortgage banking activities increased to $15.6 million from $12.1 million in the quarter and to $27.2 million from $23.3 million year to date. Mortgage originations were $559.7 million in the second quarter, up 11.4% from the prior-year quarter.
- Other expenses increased materially, primarily because merger-related transaction costs were approximately $2.0 million in the quarter and $4.0 million year to date.
- On May 26, 2016, the company sold seasoned, re-performing mortgage loans and REO with a $430.7 million unpaid principal balance for approximately $362.0 million. Net proceeds after repaying the Citi Loan Repurchase Facility were $94.6 million. The sale reduced future investment income.
- The fair value of investment portfolio assets subject to recurring fair value measurement declined from $686.3 million at year-end 2015 to $306.2 million at June 30, 2016, largely reflecting the loan portfolio sale.
Guidance, Outlook, Risks and Unusual Items
- The company entered into a proposed merger with Sutherland Asset Management Corporation. Closing was expected by the end of the fourth quarter of 2016, subject to stockholder, regulatory and other customary conditions. The transaction had not closed as of the filing date.
- If the merger closed, the existing external advisory agreement would terminate and the company would pay ZAIS REIT Management an $8.0 million termination fee. Waterfall Asset Management would become the external manager.
- Because the seasoned loan portfolio was sold, management stated that investment income would decline and that dividends could be reduced or curtailed if the merger was not completed. The company declared dividends of $0.40 per share and OP unit for each of the first two quarters of 2016.
- The Credit Suisse loan repurchase facility, with $34.0 million outstanding at June 30, 2016, was not expected to be renewed at its September 30, 2016 maturity. The company was seeking replacement financing.
- One $20.0 million warehouse facility matured July 31, 2016 and was extended to September 30, 2016; it had $13.1 million outstanding at June 30, 2016. Other warehouse and repurchase facilities also had maturities during 2016.
- The $57.5 million principal amount of 8.0% Exchangeable Senior Notes was due November 15, 2016. If the merger did not close, management intended to settle the obligation using cash balances.
- Liquidity risks included reliance on warehouse lines and repurchase agreements, collateral and margin-call requirements, non-renewal of financing, counterparty defaults and the need to distribute at least 90% of REIT taxable income.
- MSR values were sensitive to interest rates and prepayment speeds. The company also faced credit risk from non-Agency RMBS and mortgage loans, interest-rate risk on floating-rate debt and potential loan repurchase or indemnification obligations.
- GMFS maintained a $3.6 million loan indemnification reserve. A counterparty claim related to historical loan sales remained unresolved; the company could not estimate the likelihood or amount of loss. An escrow balance of approximately $4.0 million and contingent consideration were potential sources of recovery, but may not cover all losses.
- At June 30, 2016, the company reported compliance with significant debt covenants and all margin-call requirements. Management stated that identified liquidity sources were expected to meet short-term and long-term needs, although additional financing might be required.
Investor Verification Points
- Confirm the issuer identity: the provided filing is for ZAIS Financial Corp., not Ready Capital Corp.
- Verify the status and final terms of the proposed Sutherland merger, including the tender offer, stock issuance, management transition and potential $8.0 million termination fee.
- Verify refinancing or replacement of the Credit Suisse facility and the status of warehouse facilities maturing in 2016.
- Assess the company’s ability to repay or exchange the $57.5 million Exchangeable Senior Notes due November 15, 2016.
- Evaluate whether post-sale investment income and cash generation support the stated dividend policy.
- Review MSR valuation assumptions, including prepayment speeds, discount rates and servicing costs, and their sensitivity to interest-rate changes.
- Monitor the unresolved GMFS representation-and-warranty matter, the $3.6 million reserve, the $4.0 million escrow and the $11.7 million contingent consideration liability.
- Reconcile non-GAAP Core Earnings with GAAP results and determine whether recurring earnings support dividends and leverage.