Business Context and Reporting Period
The provided filing is ZAIS Financial Corp.’s Form 10-K for the fiscal year ended December 31, 2013, filed March 12, 2014. It is not filed under the name Ready Capital Corp.; investors should verify the issuer identity and any corporate name-change history. The filing includes unaudited fourth-quarter 2013 results.
ZAIS Financial was an externally managed mortgage REIT focused primarily on performing and re-performing residential mortgage loans and non-Agency RMBS. It had no employees and operated through ZAIS Financial Partners, L.P., with ZAIS REIT Management, LLC as its external advisor.
Key Financial Metrics
| Metric | 2013 | 2012 |
|---|---|---|
| Total interest income | $26.4 million | $9.4 million |
| Net interest income | $19.3 million | $8.0 million |
| Total other gains/(losses) | $(2.2) million | $16.4 million |
| Total expenses | $9.6 million | $4.2 million |
| Net income | $7.6 million | $20.3 million |
| Net income attributable to common stockholders | $6.7 million | $19.4 million |
| Basic and diluted EPS | $0.92 | $7.13 |
| Core Earnings, non-GAAP | $9.7 million; $1.16 per share | $5.7 million; $2.04 per share |
| Net cash from operating activities | $8.1 million | $2.6 million |
| Total assets at period end | $620.1 million | $201.6 million |
| Total stockholders’ equity at period end | $177.8 million | $65.1 million |
| Stockholders’ equity per share and OP unit | $19.98 | $21.68 |
Reported net income was affected substantially by fair-value changes, realized RMBS losses and derivative gains. The filing does not provide a consolidated GAAP operating margin; net interest income represented approximately 73% of interest income in 2013, compared with approximately 85% in 2012.
Fourth-Quarter 2013 Results
| Metric | Q4 2013 | Q3 2013 |
|---|---|---|
| Interest income | $8.8 million | $8.3 million |
| Net interest income | $5.7 million | $5.9 million |
| Total other gain/(loss) | $6.0 million | $1.2 million |
| Net income | $9.0 million | $4.1 million |
| Net income attributable to common stockholders | $8.1 million | $3.7 million |
| Basic EPS | $1.01 | $0.47 |
Portfolio, Debt and Liquidity
- Mortgage loans had fair value of $331.8 million at December 31, 2013, against unpaid principal balance of $398.8 million. The portfolio included $321.5 million of performing loans and $10.2 million of non-performing loans.
- RMBS had fair value of $226.2 million, consisting entirely of non-Agency RMBS. The company held no Agency RMBS at year-end.
- Weighted-average unlevered yields were 6.91% for mortgage loans and 6.57% for RMBS. Net interest spreads, including hedging, were 3.91% for mortgage loans and 4.61% for non-Agency RMBS.
- Debt included $236.1 million under the Loan Repurchase Facility, $138.6 million under securities repurchase agreements and $57.5 million principal amount of 8.0% Exchangeable Senior Notes due 2016. The notes had a carrying value of $54.5 million.
- The reported leverage ratio was 2.42x. Repurchase borrowings were generally short-term, with the loan facility maturing within 91–180 days and securities repurchase agreements generally maturing within 90 days.
- Cash was $57.1 million, restricted cash was $2.1 million and the reported liquidity cushion was $94.3 million. The company stated that it had satisfied all margin calls through year-end.
- Cash used in investing activities was $386.8 million, while financing activities provided $416.7 million. The company had no off-balance-sheet arrangements.
Material Changes Versus the Prior Comparable Period
- The February 2013 IPO generated $118.9 million of net proceeds and materially increased capitalization and portfolio capacity.
- The company acquired $334.2 million of mortgage loans and expanded from no mortgage-loan portfolio at year-end 2012 to $331.8 million of fair value at year-end 2013.
- The portfolio shifted toward residential mortgage credit strategies. Whole loans represented 54% of equity allocation, and remaining Agency RMBS were sold.
- Non-Agency RMBS fair value increased from $100.9 million to $226.2 million, while total RMBS fair value increased from $170.7 million to $226.2 million because the company exited Agency RMBS.
- Interest income and net interest income increased substantially with portfolio growth, but total other gains declined from a $16.4 million gain to a $2.2 million loss. RMBS results included a $7.2 million unrealized loss, $9.0 million realized loss and $1.1 million of other-than-temporary impairment.
- Net income attributable to common stockholders declined to $6.7 million from $19.4 million, and EPS declined to $0.92 from $7.13, partly because 2012 benefited from a $17.8 million unrealized RMBS gain.
- The company issued $57.5 million of Exchangeable Senior Notes in November 2013 and reduced its interest-rate swap notional from $32.6 million to $17.2 million.
- Advisory fees increased to $2.6 million from $0.9 million, professional fees to $3.5 million from $1.2 million, and general and administrative expenses to $2.6 million from $0.2 million, reflecting the larger public-company platform and expanded operations.
Outlook, Risks and Unusual Items
- Management intended to expand into newly originated residential mortgage loans, but had not begun originating or purchasing them as of year-end.
- The company’s strategy depended on net interest spreads, asset valuations, credit performance, financing availability, prepayment speeds and interest-rate hedging.
- Key risks included short-term repurchase financing and margin calls, rising funding costs, interest-rate and yield-curve changes, credit losses, non-Agency RMBS valuation uncertainty, illiquidity, counterparty risk and concentration in California and Florida mortgage exposure.
- Fair values for mortgage loans and non-Agency RMBS were primarily Level 3 measurements and depended on assumptions regarding prepayments, defaults, delinquencies, loss severity and home prices.
- The $0.55 per-share special dividend declared for the fourth quarter distributed 2013 taxable income attributed to termination of interest-rate swaps. Total 2013 dividends declared were $2.12 per share.
- The company was externally managed under an advisory agreement providing a fee equal to 1.5% annually of stockholders’ equity, with no performance fee. The agreement included a termination fee equal to three times the average annual advisory fee under specified circumstances.
- Maintaining REIT qualification and exemption from registration under the Investment Company Act were essential to the business model. Failure could result in corporate taxes, forced asset sales, reduced leverage or significant changes to operations.
- The filing reports no material legal proceedings or accrued litigation contingencies as of December 31, 2013. Management stated that disclosure controls and internal control over financial reporting were effective; the auditor attestation was not required because the company was an emerging growth company.
- Subsequent to year-end, the board approved an exclusive forum provision for specified stockholder and internal-affairs litigation in Maryland courts.
Investor Verification Items
- Verify whether this filing belongs to Ready Capital Corp. or to its predecessor, ZAIS Financial Corp., because the filing’s registrant name is ZAIS Financial Corp.
- Reconcile GAAP net income with Core Earnings and distinguish recurring net interest income from fair-value gains, realized losses and derivative results.
- Review the maturity, haircuts, renewal terms and cross-default provisions of the $374.7 million of repurchase borrowings.
- Assess the sensitivity of liquidity and book value to non-Agency RMBS valuations, mortgage credit losses, prepayment assumptions and margin calls.
- Review the 2016 Exchangeable Senior Notes, including the 8.0% coupon, exchange features, potential dilution and refinancing or repayment requirements.
- Confirm the sustainability of the $2.12 per-share 2013 dividend, including the special dividend and differences between taxable income, GAAP income and cash flow.
- Evaluate external-manager dependence, related-party transactions and the 1.5% advisory fee structure.