Business Context and Reporting Period
This Form 10-Q covers the quarter and nine months ended September 30, 2014. The registrant named in the filing is ZAIS Financial Corp., not Ready Capital Corp. The company is an externally managed REIT investing in and financing performing and re-performing residential mortgage loans, non-Agency RMBS and other real estate-related securities.
The company had no employees, operated through its consolidated operating partnership, and held approximately 89.6% of the operating partnership at September 30, 2014. It had 7,970,886 common shares outstanding as of November 11, 2014.
Financial Performance and Key Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Total interest income | 2014: $11.0 million; 2013: $8.3 million | 2014: $31.3 million; 2013: $17.6 million |
| Net interest income | 2014: $6.5 million; 2013: $5.9 million | 2014: $18.5 million; 2013: $13.6 million |
| Total other gains/(losses) | 2014: $(1.8) million; 2013: $1.2 million | 2014: $21.9 million; 2013: $(8.2) million |
| Total expenses | 2014: $3.4 million; 2013: $3.0 million | 2014: $10.8 million; 2013: $6.9 million |
| Net income | 2014: $1.3 million; 2013: $4.1 million | 2014: $29.6 million; 2013: $(1.4) million |
| Net income attributable to common stockholders | 2014: $1.1 million; 2013: $3.7 million | 2014: $26.5 million; 2013: $(1.4) million |
| Basic EPS | 2014: $0.14; 2013: $0.47 | 2014: $3.33; 2013: $(0.20) |
| Core Earnings, non-GAAP | 2014: $3.1 million, or $0.35 per diluted share; 2013: $3.0 million, or $0.33 | 2014: $7.8 million, or $0.87 per diluted share; 2013: $6.8 million, or $0.85 |
The filing does not provide a conventional revenue or net profit margin. Net interest income represented approximately 59.2% of interest income in the quarter and 59.1% for the nine-month period.
- Total assets increased to $721.6 million from $620.1 million at December 31, 2013.
- Mortgage loans at fair value increased to $430.1 million from $331.8 million; non-Agency RMBS increased to $243.9 million from $226.2 million.
- Other Investment Securities totaled $13.4 million at September 30, 2014, versus none at year-end 2013. Real estate owned totaled $0.2 million.
- Cash was $25.8 million and restricted cash was $7.0 million, compared with $57.1 million and $2.1 million, respectively, at December 31, 2013.
- Stockholders’ equity increased to $196.7 million from $177.8 million, while book value was $22.11 per common share and OP unit, compared with $22.37 at June 30, 2014.
- Net cash provided by operating activities was $2.4 million, compared with $5.2 million in the prior-year period. Investing activities used $102.2 million, and financing activities provided $68.6 million. Cash declined by $31.3 million to $25.8 million.
Debt, Leverage and Liquidity
- Loan Repurchase Facilities totaled $293.2 million, secured by approximately $430.0 million of mortgage-loan collateral, with a weighted average rate of 2.90% and $131.8 million of unused capacity. The Citi facility was extended to May 22, 2015.
- Securities repurchase agreements totaled $165.6 million, secured by $209.8 million of non-Agency RMBS and $11.2 million of Other Investment Securities. The weighted average rate was 1.65%, with most borrowings maturing within 30 days.
- The Operating Partnership had $57.5 million principal amount of 8.0% Exchangeable Senior Notes due November 2016; the carrying value was $55.2 million and the effective interest rate was 10.2%.
- Total borrowings used to fund the portfolio were approximately $515.3 million. Management reported a 2.62x leverage ratio and a $54.0 million liquidity cushion.
- The company had a committed $100 million Credit Suisse Loan Repurchase Facility for newly originated loans but had not drawn on it at September 30, 2014.
- All reported margin calls had been satisfied, and the company stated it had never sold assets in response to a margin call. Borrowings remain subject to collateral values, haircuts, renewal risk and lender discretion.
Material Changes Versus Prior Comparable Period
- Quarterly net interest income increased 9.6%, while nine-month net interest income increased 35.7%, primarily because the mortgage-loan portfolio was fully ramped and levered.
- Quarterly net income declined 69.1% because prior-year results benefited from larger gains on RMBS and derivatives. Nine-month net income improved materially from a $1.4 million loss to $29.6 million of income, primarily due to a $23.6 million unrealized gain on mortgage loans and improved RMBS results.
- Quarterly derivative results changed from a $1.5 million gain to a $0.5 million loss. For nine months, derivatives produced a $5.5 million loss versus a $5.5 million gain in 2013.
- Mortgage-loan fair value increased 29.6% from year-end, while non-performing mortgage loans increased to $26.2 million of fair value from $10.2 million. The percentage of mortgage-loan fair value with unpaid principal exceeding current property value improved to 57.8% from 73.6%.
- Investment activity shifted toward whole loans. The company acquired $100.4 million of mortgage loans during the nine months, acquired $63.0 million of non-Agency RMBS and acquired $12.3 million of Other Investment Securities. No Agency RMBS or TBA contracts were held at quarter-end.
- The weighted average mortgage-loan net interest spread increased to 4.20% from 3.50%; the spread for non-Agency RMBS and Other Investment Securities increased to 5.12% from 4.66%.
Outlook, Commentary, Risks and Unusual Items
Management stated that economic growth continued but the future path of interest rates remained uncertain. Housing and mortgage-credit fundamentals were viewed as supportive, although home-price appreciation was decelerating. The company completed the operational rollout of a newly originated residential-loan purchase program and expected to expand through an independent loan-seller network and the GMFS platform.
- On October 31, 2014, after the reporting date, the company completed its acquisition of GMFS for a preliminary purchase price of approximately $62.8 million. The closing payment included approximately $34.8 million of mortgage servicing rights. Additional consideration includes two contingent $1 million payments and up to $20 million of contingent consideration tied to profitability and loan production.
- The GMFS acquisition was funded with available cash and liquidation of a portion of the non-Agency RMBS portfolio. GMFS originated approximately $991 million of mortgage loans during the first nine months of 2014.
- Management expects to continue paying quarterly distributions to maintain REIT status. Dividends of $0.40 per share were declared for each quarter in the first nine months of 2014.
- Key risks include rising short-term interest rates, declining asset values, widening spreads, slower or faster prepayments, extension risk, borrower defaults, non-Agency RMBS credit losses, margin calls, repo renewal risk, counterparty failures and reliance on the external advisor.
- Most assets are carried at fair value, and significant mortgage loans, non-Agency RMBS and Other Investment Securities are Level 3 measurements subject to assumptions regarding defaults, delinquencies, loss severity, prepayments and home prices.
- The company is dependent on the Advisor for portfolio management and operational services. The advisory agreement includes a potential termination fee equal to three times the average annual advisory fee in specified circumstances.
- The acquisition of a mortgage-origination platform introduces additional risks related to underwriting, fraud, regulatory compliance, seller/servicer approvals, repurchase obligations, reverse mortgages and retention of key personnel.
- The filing reports no legal proceedings requiring accrual or disclosure, no off-balance-sheet arrangements and effective disclosure controls as of September 30, 2014.
Important Facts for Investors to Verify
- Confirm the issuer identity: the supplied filing is for ZAIS Financial Corp., while the request identifies Ready Capital Corp.
- Reconcile the filing’s inconsistent diluted EPS references: the primary statements report $0.14 for the quarter and $2.99 for nine months, while the MD&A narrative cites $2.97 for nine months; a later EPS table also contains an apparent prior-year sign inconsistency.
- Assess the sustainability of earnings excluding substantial fair-value gains, particularly the $23.6 million nine-month unrealized mortgage-loan gain and the $5.5 million derivative loss.
- Review liquidity after the post-quarter-end $62.8 million GMFS acquisition and the associated liquidation of non-Agency RMBS.
- Evaluate refinancing, margin-call and collateral risks on the $458.8 million of repo-related borrowings and the $57.5 million exchangeable notes.
- Analyze valuation sensitivity for the predominantly Level 3 mortgage loans and non-Agency RMBS, including the effects of higher defaults, loss severity, delinquencies, prepayments and declining home prices.
- Verify GMFS integration, contingent consideration, seller/servicer compliance and the effect of the acquisition on future earnings and capital requirements.