Business Context and Reporting Period
The provided filing is ZAIS Financial Corp.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2015, not a filing under the name Ready Capital Corp. The company originates, acquires, finances, sells, services and manages residential mortgage loans; invests in non-Agency RMBS and other real-estate-related assets; and operates through two segments: residential mortgage investments and residential mortgage banking.
GMFS, acquired on October 31, 2014, expanded the company into mortgage origination, sales and servicing. The company remained externally managed by ZAIS REIT Management, LLC and had 240 GMFS employees at September 30, 2015.
Key Financial Metrics
| Metric | Three months ended September 30, 2015 | Nine months ended September 30, 2015 | Comparable period |
|---|---|---|---|
| Total interest income | $9.7 million | $28.9 million | $11.0 million and $31.3 million, respectively |
| Net interest income | $4.9 million | $14.7 million | $6.5 million and $18.5 million, respectively |
| Mortgage banking activities, net | $13.1 million | $36.3 million | No comparable prior-period activity |
| Net income attributable to common stockholders | $(6.0) million | $0.4 million | $1.1 million and $26.5 million, respectively |
| Diluted earnings per share | $(0.76) | $0.05 | $0.14 and $2.99, respectively |
| Core Earnings, non-GAAP | $4.8 million | $12.8 million | $3.1 million and $7.8 million, respectively |
Net loss before income tax was $7.0 million for the quarter and net income before tax was $2.9 million for the nine-month period. Total expenses were $12.9 million and $38.8 million, respectively. The nine-month results included a $2.5 million income-tax expense at the taxable REIT subsidiary level.
- Total assets were $779.1 million at September 30, 2015, compared with $792.4 million at December 31, 2014.
- Cash was $29.4 million and restricted cash was $4.0 million, compared with $33.8 million and $7.1 million, respectively, at year-end 2014.
- Total equity was $183.2 million, including $164.1 million attributable to ZAIS stockholders; book value per common share and OP unit was $20.58 versus $21.73 at year-end 2014.
- Mortgage loans held for investment at fair value were $401.2 million; mortgage loans held for sale were $114.7 million; non-Agency RMBS were $113.2 million; other investment securities were $15.2 million; and MSRs were $42.0 million.
- Mortgage banking generated $48.8 million of gross gain on loan sales during the nine months, with $1.4 billion of loan originations and $1.5 billion of proceeds from loan sales and principal payments.
- Cash used in operating activities was $15.4 million, cash provided by investing activities was $40.1 million, and cash used in financing activities was $29.1 million. Cash decreased by $4.4 million during the nine months.
Debt, Liquidity and Capital
- Warehouse lines of credit totaled $104.2 million at a 2.49% weighted-average rate, against aggregate borrowing capacity of $185.0 million.
- Loan repurchase facilities totaled $295.3 million at a 2.92% weighted-average rate, with total facility size of $425.0 million and unused capacity of approximately $129.7 million based on collateral availability.
- Securities repurchase agreements totaled $74.5 million at a 1.69% weighted-average rate and generally matured within 30 days.
- The 8.0% Exchangeable Senior Notes had $57.5 million principal outstanding, a carrying value of $56.2 million, and maturity in November 2016. The effective interest rate was 10.2%.
- Reported leverage was 2.90x. Management stated that all significant debt covenants and margin-call requirements were satisfied.
- The company reported a liquidity cushion of approximately $33.5 million, excluding GMFS warehouse lines and repurchase agreements, and believed identified liquidity sources were adequate for short-term needs.
Material Changes Versus Prior Comparable Period
- Third-quarter GAAP results shifted from $1.3 million of net income in 2014 to a $6.7 million net loss in 2015. Nine-month GAAP net income declined from $29.6 million to $0.4 million.
- The principal negative drivers were fair-value losses on mortgage loans held for investment, RMBS and other investment securities, totaling $8.2 million in the third quarter and $10.1 million for the nine-month period, compared with gains in several comparable 2014 categories.
- Mortgage banking and servicing income were new contributors following the GMFS acquisition, including $36.3 million of mortgage banking income and $5.0 million of net servicing fee income for the nine months.
- MSRs increased from $33.4 million at year-end 2014 to $42.0 million, but the company recorded a $5.9 million third-quarter fair-value decline, primarily reflecting lower interest rates and related prepayment assumptions.
- Non-Agency RMBS declined from $148.6 million to $113.2 million, while other investment securities increased from $2.0 million to $15.2 million.
- Operating expenses rose substantially because of GMFS salaries, commissions, benefits and operating costs. Nine-month salaries, commissions and benefits were $23.2 million, with no comparable prior-period expense.
- The company declared quarterly dividends of $0.40 per common share for each of the first three quarters of 2015, unchanged from the comparable 2014 quarterly amounts.
Outlook, Risks, Contingencies and Unusual Items
- Management attributed third-quarter weakness to lower interest rates, increased credit-spread volatility and declining fair values in the whole-loan and RMBS portfolios. Lower rates supported refinancing volumes but reduced MSR values.
- The company engaged a financial advisor to evaluate potential strategic alternatives to enhance shareholder value.
- The company was evaluating alternatives to repay or refinance the Exchangeable Senior Notes at maturity, including refinancing or asset sales.
- GMFS had a statute-of-limitations tolling agreement with a counterparty concerning historical loan-sale representations and warranties. Management stated that litigation seeking substantial damages was probable if the matter was not extended or settled, but could not reasonably estimate probable losses or the potential loss range. Recorded reserves could be inadequate, and losses exceeding reserves and contingent consideration could materially affect results, financial position or cash flows.
- GMFS had approximately $249.1 million of commitments to originate loans at September 30, 2015. These commitments expose the company to interest-rate, market, credit and loan-pull-through risks.
- The company’s financing is dependent on warehouse lines and repurchase facilities that may not be renewed. A GMFS repurchase agreement with $65.0 million of committed capacity was scheduled to expire November 27, 2015, and renewal discussions were ongoing.
- Repurchase financing creates margin-call and collateral risks. Declines in asset values, higher haircuts or increased prepayments could require additional collateral, repayment of borrowings or asset sales.
- A hypothetical 50-basis-point increase in LIBOR was estimated to increase quarterly interest expense by approximately $0.6 million on $456.9 million of variable-rate debt, before considering broader economic effects.
- The filing recorded a $96,000 out-of-period adjustment to mortgage banking activities to reverse previously reported unrealized gains on mortgage loans held for sale that had been sold. Management concluded previously issued financial statements were not materially misstated.
Facts Investors Should Verify
- Issuer identity: Confirm whether the requested company should be ZAIS Financial Corp.; the supplied filing does not identify Ready Capital Corp.
- GMFS legal exposure: Review subsequent filings for developments in the historical loan-sale representations and warranties dispute, reserve changes and any indemnification recovery.
- Refinancing and maturities: Verify renewal of GMFS financing facilities and the eventual settlement or refinancing of the $57.5 million Exchangeable Senior Notes due in 2016.
- Fair-value sensitivity: Assess assumptions for MSR prepayments, discount rates, mortgage defaults, loss severity and non-Agency RMBS valuations, most of which rely on Level 3 inputs.
- Liquidity and leverage: Reconcile reported cash, restricted cash, collateral availability, unused borrowing capacity, margin requirements and the 2.90x leverage ratio.
- Dividend sustainability: Compare future taxable income, Core Earnings, GAAP earnings and cash flows with the continuing $0.40-per-share quarterly distribution policy.