Business Context and Reporting Period
The filing is ZAIS Financial Corp.’s unaudited Form 10-Q for the three months ended March 31, 2013. The supplied metadata identifies Ready Capital Corp., but the filing itself identifies the registrant as ZAIS Financial Corp. The company is a Maryland REIT externally managed by ZAIS REIT Management, LLC, with substantially all operations conducted through its operating partnership.
The company invests primarily in Agency and non-Agency residential mortgage-backed securities, performing and re-performing residential whole loans, and other real estate-related assets. It completed its initial public offering on February 13, 2013, raising $118.9 million in net proceeds.
Key Financial Metrics
| Metric | March 31, 2013 / Q1 2013 | Comparable Period or Prior Date |
|---|---|---|
| Total assets | $491.7 million | $201.6 million at December 31, 2012 |
| RMBS at fair value | $455.9 million | $170.7 million at December 31, 2012 |
| Mortgage loans at fair value | $10.8 million | None at December 31, 2012 |
| Repurchase agreements | $295.6 million | $116.1 million at December 31, 2012 |
| Total stockholders’ equity | $191.3 million | $65.1 million at December 31, 2012 |
| Interest income | $3.4 million | $2.8 million in Q1 2012 |
| Net interest income | $2.9 million | $2.5 million in Q1 2012 |
| Total other gains | $1.2 million | $4.6 million in Q1 2012 |
| Net income | $2.0 million | $6.2 million in Q1 2012 |
| Net income attributable to common stockholders | $1.7 million | $6.2 million in Q1 2012 |
| Basic and diluted EPS | $0.32 | $2.06 in Q1 2012 |
| Core Earnings, non-GAAP | $0.8 million; $0.13 per share | $1.7 million; $0.55 per share in Q1 2012 |
| Net cash from operating activities | $0.1 million | $0.8 million in Q1 2012 |
| Net cash used in investing activities | $299.5 million | $36.9 million in Q1 2012 |
| Net cash from financing activities | $293.1 million | $36.0 million in Q1 2012 |
| Cash and restricted cash | $22.7 million | $22.8 million at December 31, 2012 |
Portfolio, Leverage and Liquidity
- The RMBS portfolio comprised $182.3 million of Agency RMBS and $273.6 million of non-Agency RMBS at fair value. The portfolio’s weighted-average unleveraged yield was 4.80%.
- The company acquired Agency RMBS with a principal balance of $111.0 million for $115.4 million, non-Agency RMBS with a principal balance of $216.7 million for $175.1 million, and mortgage loans with a principal balance of $17.7 million for $10.8 million.
- Repurchase borrowings were secured by approximately $354.4 million of RMBS collateral. Haircuts ranged from 3% to 5% for Agency RMBS and 15% to 40% for non-Agency RMBS.
- The effective leverage ratio was 2.05x, including $109.5 million of Agency RMBS exposure from TBA contracts. The company reported a $103.7 million liquidity cushion and $9.9 million of restricted cash.
- Interest-rate swaps had $169.4 million of notional value and effectively fixed the rates on a portion of borrowings. TBA purchase contracts had $104.0 million of notional value.
Material Changes Versus Prior Comparable Period
- Interest income increased 24% to $3.4 million, primarily because of a larger average investment portfolio, partly offset by lower average asset yields.
- Interest expense increased to $0.5 million from $0.3 million as repurchase borrowings grew.
- Net interest spreads narrowed: Agency RMBS to 1.58% from 2.69%, and non-Agency RMBS to 3.97% from 4.72%, including hedging effects.
- Net income declined to $2.0 million from $6.2 million. The prior-year period benefited from a $6.5 million unrealized gain, while the current period included only a $0.9 million unrealized gain and no realized investment loss.
- Professional fees rose to $1.3 million from $0.5 million, primarily due to year-end audit costs and increased public-company reporting requirements. Advisory fees increased to $0.5 million from $0.2 million following the IPO, and general and administrative expenses increased to $0.4 million from $0.04 million.
- The company’s assets, equity and repurchase borrowings expanded substantially following the IPO and rapid deployment of capital. Management stated that the company was fully deployed with IPO proceeds but not yet fully invested or leveraged to its long-term plan; therefore, Q1 results are not indicative of expected results at full scale.
- The company recognized no other-than-temporary impairment in Q1 2013, compared with $0.1 million in Q1 2012.
Outlook, Risks, Contingencies and Unusual Items
- Management expects operating results to depend primarily on net interest spreads, asset fair values, available financing, prepayment speeds, interest rates, credit performance and the supply and demand for target assets. No quantitative earnings guidance was provided.
- Repurchase agreements are generally renewable at lender discretion and are due within one year. Declines in collateral values, higher haircuts or margin calls could materially reduce liquidity. The company reported that it had satisfied all margin calls and had not sold assets in response to a margin call.
- Non-Agency RMBS, whole loans and Level 3 fair values are exposed to defaults, delinquencies, loss severity, prepayments, home prices and market liquidity. Significant changes in these assumptions could materially affect earnings and book value.
- Interest-rate swaps mitigate exposure to higher short-term rates but introduce derivative valuation risk, extension risk and potential losses if prepayments differ materially from assumptions. A hypothetical 50-basis-point increase in LIBOR would increase quarterly interest expense on unhedged variable-rate debt by approximately $0.2 million, assuming no balance-sheet changes.
- The company is externally managed and depends on its Advisor for investment selection, valuation and daily operations. The Advisor may seek reimbursement of certain expenses in the future, which could increase the expense ratio.
- The company intends to maintain REIT qualification and must distribute at least 90% of annual taxable income. Failure to qualify could result in corporate-level taxes and materially reduce distributions.
- A $0.22 per-share dividend for common stock and OP units was declared on May 14, 2013, payable May 31, 2013.
- No significant legal proceedings, material contingencies requiring accrual, or off-balance-sheet arrangements were reported. Management concluded that disclosure controls were effective.
Investor Verification Checklist
- Confirm the registrant’s identity: the supplied filing is for ZAIS Financial Corp., not Ready Capital Corp.
- Verify the sustainability of net interest spreads after the substantial increase in leverage and portfolio size.
- Review the valuation assumptions and sensitivity of the $273.6 million Level 3 non-Agency RMBS portfolio.
- Assess repurchase-agreement refinancing, collateral haircuts, margin-call exposure and the reported $103.7 million liquidity cushion.
- Reconcile GAAP net income of $2.0 million with non-GAAP Core Earnings of $0.8 million and determine the appropriate recurring earnings measure.
- Evaluate related-party purchases, advisory fees and the Advisor’s potential expense reimbursements.
- Confirm future distributions against taxable income, REIT requirements and available liquidity.