Business Context and Reporting Period
The filing is ZAIS Financial Corp.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2013, filed November 12, 2013. The submitted metadata identifies Ready Capital Corp., but the filing registrant is ZAIS Financial Corp.; this entity identification should be verified.
The company is an externally managed REIT investing primarily in performing and re-performing residential mortgage loans and non-Agency residential mortgage-backed securities (RMBS). It conducts substantially all operations through its operating partnership and had no employees. The company completed a $120.1 million gross initial public offering in February 2013.
Financial Results and Key Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Total interest income | $8.3 million, versus $2.2 million | $17.6 million, versus $7.2 million |
| Net interest income | $5.9 million, versus $1.8 million | $13.6 million, versus $6.2 million |
| Total other gains/(losses) | $1.2 million, versus $6.8 million | $(8.2) million, versus $13.4 million |
| Net income/(loss) | $4.1 million, versus $8.1 million | $(1.4) million, versus $17.6 million |
| Net income/(loss) attributable to common stockholders | $3.7 million, versus $8.1 million | $(1.4) million, versus $17.6 million |
| Basic and diluted EPS | $0.47, versus $2.83 | $(0.20), versus $5.94 |
| Core Earnings, non-GAAP | $3.0 million, versus $1.3 million | $6.8 million, versus $4.2 million |
Net interest margin information was disclosed as weighted-average net interest spread, including hedging: 3.50% for mortgage loans and 4.66% for non-Agency RMBS at September 30, 2013. Core Earnings per weighted-average share was $0.33 for the quarter and $0.85 for the nine-month period.
| Balance Sheet Metric | September 30, 2013 | December 31, 2012 |
|---|---|---|
| Total assets | $559.5 million | $201.6 million |
| Mortgage loans at fair value | $334.8 million | None reported |
| Real estate securities at fair value | $196.6 million | $170.7 million |
| Cash | $21.5 million | $19.1 million |
| Restricted cash | $3.0 million | $3.8 million |
| Total liabilities | $382.3 million | $136.5 million |
| Total stockholders’ equity | $177.2 million | $65.1 million |
| Leverage ratio | 2.11x | Not clearly provided in the filing text |
Cash provided by operating activities was $5.2 million for the first nine months of 2013, compared with $3.1 million in the prior-year period. Investing activities used $368.1 million, primarily for mortgage loan and RMBS acquisitions. Financing activities provided $365.2 million, including $118.9 million of net IPO proceeds and borrowings under repurchase facilities. Cash increased by $2.4 million to $21.5 million.
Material Changes Versus Prior Comparable Period
- The portfolio expanded substantially following the IPO and the acquisition of residential mortgage loans. Mortgage loans had a September 30 fair value of $334.8 million, compared with none at December 31, 2012.
- The company acquired mortgage loans with approximately $412.9 million of unpaid principal balance for $334.2 million during the first nine months, including approximately $260.6 million of principal balance during the third quarter.
- The company sold its remaining Agency RMBS during the third quarter and ended the period focused on residential mortgage credit strategies. Non-Agency RMBS increased to $196.6 million from $100.9 million at December 31, 2012, while total RMBS increased from $170.7 million.
- The company entered into a $250 million Loan Repurchase Facility in May 2013 and had $240.5 million outstanding at September 30. Securities repurchase borrowings increased to $134.1 million from $116.1 million at year-end 2012.
- Net interest income increased materially because of the larger whole-loan and RMBS portfolios, but earnings were reduced by RMBS sale losses, fair-value volatility and higher operating expenses.
- Expenses increased with the company’s public-company status and larger capitalization. Nine-month professional fees increased to $2.6 million, advisory fees to $1.9 million and general and administrative expenses to $2.0 million.
- The company redeemed all 133 shares of its 12.5% Series A preferred stock in February 2013.
Outlook, Commentary, Risks and Unusual Items
Management stated that the company had achieved its targeted equity allocation to residential whole loans, with 53% of equity allocated to whole-loan investments at September 30, 2013. It planned to develop a newly originated residential mortgage loan strategy but had not yet begun purchasing newly originated loans.
Management intended to distribute all or substantially all taxable income through dividends declared by December 31, 2013, but stated that the amount could be affected by future events and expenses. A quarterly dividend of $0.50 per common share and OP unit was declared on September 18, 2013. Undistributed taxable income was approximately $1.07 per share, primarily related to the termination of interest rate swaps.
For the quarter, RMBS sales produced an $8.0 million net realized loss, including $1.1 million of other-than-temporary impairment. The company also recorded a $4.8 million unrealized gain on RMBS, a $3.6 million unrealized gain on mortgage loans and $1.5 million of net derivative gains. For the nine months, RMBS produced a $9.4 million net realized loss and a $10.0 million unrealized loss.
- Liquidity and margin risk: Repurchase borrowings are subject to collateral haircuts, margin calls and lender renewal discretion. The company reported satisfying all margin calls and a $32.6 million liquidity cushion, but stated that additional financing may be required for longer-term needs.
- Interest-rate risk: Approximately $357.3 million of debt remained variable-rate after considering $17.2 million of interest-rate swaps. Management estimated that a 50-basis-point increase in LIBOR would increase quarterly interest expense by approximately $0.4 million, assuming no structural changes.
- Credit and valuation risk: Mortgage loans and non-Agency RMBS were principally classified as Level 3 fair value assets. Valuations depend on default, delinquency, loss-severity, prepayment and home-price assumptions.
- Portfolio concentration: Approximately 74.1% of mortgage-loan fair value had an unpaid-principal-balance-to-current-property-value ratio above 100%. California and Florida represented 25.6% and 18.0% of mortgage-loan fair value, respectively.
- REIT qualification: Failure to satisfy REIT income, asset or distribution requirements could materially adversely affect results. The filing also identifies uncertainty regarding whether TBA transactions qualify under the REIT tests.
- External management and related parties: The company depends on its Advisor and incurred $1.9 million of advisory fees during the first nine months. It also purchased $15.7 million of RMBS from a ZAIS-managed fund during the period.
- Legal and controls: Management reported no legal proceedings requiring disclosure, no material changes to reported risk factors except the TBA issue, and effective disclosure controls as of September 30, 2013.
Important Facts for Investors to Verify
- Confirm whether the intended issuer is ZAIS Financial Corp. or Ready Capital Corp.; the filing text identifies ZAIS Financial Corp.
- Reconcile GAAP net loss for the first nine months with Core Earnings of $6.8 million and assess the sustainability of earnings excluding fair-value and realized gains or losses.
- Review the valuation assumptions supporting $531.3 million of Level 3 mortgage loans and non-Agency RMBS.
- Assess collateral coverage, haircuts, maturity and renewal terms for the $374.5 million of repurchase borrowings and the company’s ability to withstand margin calls.
- Evaluate credit exposure from non-performing loans, high loan-to-property-value balances, non-Agency RMBS and geographic concentrations.
- Verify the amount and timing of future taxable-income distributions, including the effect of terminated swaps and REIT distribution requirements.
- Review related-party purchases, advisory fees and the potential termination fee under the external management agreement.