Ready Capital Corp. — Filing Summary
Filing identity: The provided Form 10-K is for ZAIS Financial Corp. (NYSE: ZFC), not Ready Capital Corp. It covers the fiscal year ended December 31, 2015, and was filed March 10, 2016. The summary below reflects the provided filing.
Business Context and Reporting Period
ZAIS Financial was an externally managed Maryland REIT investing primarily in residential mortgage loans, non-Agency RMBS, mortgage servicing rights (MSRs), and related assets. Following its October 2014 acquisition of GMFS, the Company operated two segments: residential mortgage investments and residential mortgage banking.
GMFS originated, sold, and serviced residential mortgage loans through retail, correspondent, and broker channels. It was approved as a Fannie Mae and Freddie Mac seller-servicer, a Ginnie Mae issuer, and an FHA, USDA, and VA-approved originator or lender. GMFS had 246 employees at December 31, 2015.
Financial Performance and Key Metrics
| Metric | 2015 | 2014 |
|---|---|---|
| Total interest income | $37.8 million | $41.6 million |
| Net interest income | $19.0 million | $24.3 million |
| Mortgage banking activities, net | $45.9 million | $5.4 million |
| Loan servicing fee income, net | $7.1 million | $0.9 million |
| Change in MSR fair value | $(4.1) million | $(1.7) million |
| Other gains/(losses) | $(14.0) million | $18.9 million |
| Total expenses | $50.9 million | $19.0 million |
| Net income attributable to common stockholders | $(1.3) million | $26.7 million |
| Diluted EPS | $(0.16) | $3.08 |
| Core Earnings, non-GAAP | $13.5 million | $11.9 million |
| Book value per common share and OP Unit | $19.98 | $21.73 |
| Leverage ratio | 2.97x | 2.84x |
Net income before taxes was $3.0 million, compared with $29.0 million in 2014. The 2015 tax expense was $4.4 million, primarily at taxable REIT subsidiaries. The filing reports an effective tax rate of 147.37% for 2015, compared with a tax benefit and negative effective rate in 2014.
2015 GMFS originations totaled approximately $1.8 billion of unpaid principal balance, with $1.8 billion of mortgage loans sold. GMFS generated approximately $13.5 million of net income before taxes, compared with $0.6 million for the partial post-acquisition period in 2014.
Balance Sheet, Liquidity, Debt, and Cash Flow
| Metric at December 31 | 2015 | 2014 |
|---|---|---|
| Total assets | $775.1 million | $792.4 million |
| Total liabilities | $597.4 million | $599.0 million |
| Total equity | $177.8 million | $193.4 million |
| Cash | $20.8 million | $33.8 million |
| Restricted cash | $4.4 million | $7.1 million |
| Mortgage loans held for investment | $397.7 million | $416.0 million |
| Mortgage loans held for sale | $115.9 million | $97.7 million |
| Non-Agency RMBS | $109.3 million | $148.6 million |
| MSRs | $48.2 million | $33.4 million |
- Borrowings used to fund the portfolio totaled approximately $527.4 million, including warehouse lines, loan and securities repurchase agreements, and Exchangeable Senior Notes.
- Warehouse lines and repurchase agreements related to GMFS totaled $100.8 million at year-end, against aggregate availability of $185.0 million.
- Loan repurchase facilities totaled $296.8 million and had a weighted-average rate of 3.14%.
- Securities repurchase agreements totaled $73.3 million, with a weighted-average rate of 1.80% for non-Agency RMBS and 2.17% for other investment securities.
- The 8.0% Exchangeable Senior Notes had $57.5 million principal outstanding and mature November 15, 2016. Their effective interest rate was 10.2%.
- The Company reported a $25.0 million liquidity cushion, in addition to reserves related to the loan repurchase facilities, and $4.4 million of restricted cash.
- Cash used in operating activities was $23.1 million, compared with $4.7 million used in 2014 and $8.1 million provided in 2013.
- Cash provided by investing activities was $45.9 million, while cash used in financing activities was $35.9 million. Ending cash declined by $13.0 million to $20.8 million.
- The Company was in compliance with all significant debt covenants and reported that it had satisfied all margin calls through the filing date.
Material Changes Versus the Prior Comparable Period
- GAAP results deteriorated from $26.7 million of common-stockholder income in 2014 to a $1.3 million loss in 2015, primarily because investment portfolio losses replaced the prior year’s investment gains.
- Net interest income declined by $5.4 million as interest income fell and interest expense increased. RMBS interest income declined by approximately $6.1 million, partly offset by higher mortgage-loan-held-for-sale interest income from GMFS.
- Mortgage banking activities increased sharply to $45.9 million from $5.4 million because 2015 included a full year of GMFS operations, compared with only two months in 2014.
- Investment portfolio losses totaled $14.0 million in 2015, versus gains of $18.9 million in 2014. The principal drivers were unrealized losses on mortgage loans and RMBS amid spread widening and weaker mortgage-related market values.
- Total expenses increased to $50.9 million from $19.0 million, principally because GMFS salaries, commissions, benefits, and operating expenses were included for a full year.
- Book value per share declined from $21.73 to $19.98, while leverage increased from 2.84x to 2.97x.
- Non-Agency RMBS fair value declined by approximately $39.2 million, while MSR fair value increased by approximately $14.8 million due primarily to additional servicing retained from loan sales.
- Core Earnings increased to $13.5 million from $11.9 million, reflecting GMFS earnings of approximately $6.3 million net of taxes, partly offset by lower earnings from the residential mortgage investment portfolio.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
The Company announced a strategic review in November 2015 involving potential merger or sale transactions, or liquidation of its assets. Discussions with a potential counterparty were preliminary and there was no assurance of a definitive transaction. If no transaction occurred, management intended to present a possible liquidation plan to the Board, subject to Board and stockholder approval.
- The Company began selling its seasoned, re-performing mortgage loans, with an expected completion in early second quarter 2016. Management warned that the sale could reduce investment income and lead to curtailed dividends.
- The Company decided to stop purchasing newly originated residential mortgage loans through its conduit program and unwind that business.
- Chief Investment Officer Brian Hargrave resigned effective March 9, 2016, and was expected to be succeeded by Chairman Christian Zugel.
- The Exchangeable Senior Notes mature in November 2016. The Company was evaluating alternatives for repayment or settlement in light of the strategic review.
- GMFS faced a potential substantial representation-and-warranty claim involving approximately $1 billion of historical mortgage loan sales from 1999 through 2006. A tolling agreement was extended through June 2, 2016. The Company could not determine the likelihood of the outcome.
- The Company maintained a $3.2 million loan indemnification reserve and had access to a $4.0 million GMFS seller escrow account. Losses exceeding the reserve, contingent consideration, and escrow could materially affect earnings, financial position, or cash flow.
- Contingent consideration related to the GMFS acquisition was $11.3 million at December 31, 2015, with potential additional consideration capped at $20 million for the production and profitability earn-out, plus deferred premiums.
- Key risks included short-term financing renewals, margin calls, rising LIBOR, interest-rate and prepayment risk, credit losses, valuation uncertainty in Level 3 assets, MSR sensitivity to prepayments, counterparty exposure, regulatory compliance, REIT qualification, and reliance on the external Advisor.
- The Company declared quarterly dividends of $0.40 per share and OP Unit during 2015, or $1.60 for the year. A portion of dividends was characterized as return of capital for tax purposes. Management stated that future distributions could be reduced.
- No other-than-temporary impairment was recorded for RMBS in 2015 or 2014, and no goodwill or intangible-asset impairment was recorded in 2015.
Most Important Facts for an Investor to Verify
- Confirm the issuer: the supplied filing is ZAIS Financial Corp., not Ready Capital Corp.
- Verify the outcome of the strategic review, including any merger, sale, liquidation, or portfolio-sale transactions.
- Verify repayment, refinancing, or exchange of the $57.5 million Exchangeable Senior Notes due November 2016.
- Review subsequent developments regarding the GMFS representation-and-warranty claim and whether the $3.2 million reserve and $4.0 million escrow were adequate.
- Assess the effect of selling re-performing loans and unwinding the conduit program on recurring interest income, liquidity, leverage, and dividends.
- Reconcile Core Earnings with GAAP earnings and evaluate the effect of fair-value losses, Level 3 valuation assumptions, and nonrecurring items.
- Review renewal terms and current availability under the loan repurchase facilities, warehouse lines, and securities repurchase agreements.
- Confirm continued REIT qualification and the treatment of dividends, including return-of-capital components.