ZAIS Financial CEO Discusses Q4 2013 Results - Earnings Call Transcript

Mar. 5.14 | About: ZAIS Financial (ZFC)

ZAIS Financial (NYSE:ZFC)

Q4 2013 Earnings Conference Call

March 04, 2014 10:00 AM ET


Scott Eckstein - Financial Relations Board

Michael Szymanski - CEO, President and Director

Paul McDade - CFO and Treasurer

Brian Hargrave - CIO


Mike Widner - Keefe, Bruyette & Woods, Inc.

Jim Young - West Family Investments


Welcome to the ZAIS Financial Corporation’s Fourth Quarter 2013 Conference Call. During today’s presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today Wednesday, March 5, 2014. I would now like to turn the conference over to Scott Eckstein. Please go ahead sir.

Scott Eckstein

Thank you, operator. Good day everyone and welcome to ZAIS Financial Corp’s conference call to review the Company’s results for the fourth quarter and full year ended December 31. On the call today will be Michael Szymanski, President and Chief Executive Officer; Paul McDade, Chief Financial Officer and Treasurer; and Brian Hargrave, Chief Investment Officer.

As a reminder, this call is being recorded, also being webcast through the Company’s website Additionally, a copy of the Company’s fourth quarter investor presentation is available for your review on the Company’s website on the Investor Relations page.

Before we begin, I’d like to remind everyone that during the course of this conference call, both in our prepared remarks and in answers to your questions, we may make certain statements and assumptions that contain or based upon forward-looking information pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

Such forward-looking statements are subject to numerous assumptions, uncertainties and known or unknown risks, which could cause actual results to differ materially from those anticipated. These risk factors are more fully discussed in the Company’s filings with the Securities and Exchange Commission.

The forward-looking statements included in this conference call are only made as of the date of this call and the Company is not obligated to publicly update or revise them. In addition, certain terms used in this call are non-GAAP financial measures, reconciliations of which are provided in the Company’s earnings release and accompanying tables, which have been furnished to the SEC through the Company’s Form 8-K this morning and may also be accessed through the Company’s website at Each listener is encouraged to review those reconciliations provided in the earnings release together with all of the information provided in the release.

I will now turn the call over to Michael Szymanski. Please go ahead sir.

Michael Szymanski

Good morning everyone. Thanks for joining us today. We are pleased to present our financial results for the fourth quarter of 2013, which demonstrates the strength of our mortgage credit focused investment strategy. During this morning’s call, I’ll briefly discuss our financial results and our other achievements during the quarter. After that our CFO, Paul McDade, will review our financial results in more detail and our CIO, Brian Hargrave will discuss the mortgage credit market environment and recap our portfolio performance.

Despite the announcement of the Fed’s decision to begin tapering bond purchases, interest rates remained range bound in the fourth quarter and volatility was subdued. Economic fundamentals strengthened during the quarter although we have seen signs in early 2014 that this strength may have been somewhat bleeding. At the same time, housing fundamentals remain solid appearing to have largely shaken off higher interest rates in 2013. As noted in today’s press release for the fourth quarter of 2013, we reported core earnings of $3 million or $0.31 per diluted weighted average share outstanding. On a GAAP basis, we reported net income of 9 million for the quarter or $0.98 per diluted weighted average share outstanding.

The main difference between core and GAAP earnings was net realized, unrealized gains in our portfolio mortgage loans and RMBS recorded under GAAP which Paul discussed in more detail. Book value per share of common stock and OP units as of December 31, 2013 was $19.98 compared with $19.92 at September 30, 2013. As previously announced in the fourth quarter, our Board of Directors declared a regular cash dividend of $0.40 per share of common stock and OP unit and an additional special cash dividend of $0.55 per share of common stock and OP unit which were paid on January 15, 2014 to stockholders and OP unit holders on record as of December 31, 2013.

The company declared a special cash dividend to distribute taxable income from 2013 attributable to the termination of interest rate swap contracts. In November of 2013, we successfully completed the issuance of 57.5 million in convertible notes. This is an important transaction for ZFC as we expect it to be accretive to earnings. At the same time, it provides us with additional capital to pursue our residential mortgage credit investment strategies consistent with our long-term business plan. Also our success in completing this transaction speaks positively on the differentiation of our strategy, given our continued ability to access capital in this market environment.

During the fourth quarter, our capital allocation to whole loans remained relatively stable at 54%. Our securities portfolio at December 31, 2013 had a fair market value of $226.2 million, up from September 30, 2013 value of a 196.6 million.

Importantly, we saw significant gains in both our whole loan and our non-agency RMBS portfolios in this quarter. As a result, we grew book value in the quarter while declaring a total of $0.95 per share in regular and special dividends. During the quarter, we also continued to invest resources in our whole loan platform. We believe this investment provides us with the ability to grow further our legacy whole loan portfolio while also moving us closer to launching our newly originated loan purchase program.

I will now turn the call over to our Chief Financial Officer, Paul McDade to review our financial performance.

Paul McDade

Thanks Mike good morning everyone. As Mike already mentioned for the quarter ended December 31, 2013 the Company reported GAAP net income of $9 million or $0.98 per diluted weighted average share outstanding. Core earnings for the quarter were $3 million or $0.31 per diluted weighted average share outstanding. The difference between GAAP and core earnings was due to net realized and unrealized gains of $6 million on our portfolio recorded under GAAP. You can reference the section of our press release entitled use of non-GAAP financial information for a further explanation of core earnings which is a non-GAAP financial measure.

As noted in our release and past earnings discussions we believe providing investors core earnings information is important when assessing the performance of the quarter as it offers greater transparency to the information that our management team uses in its financial and operational decision making process.

The Company recorded net interest income of $5.7 million for the fourth quarter of 2013, compared with $1.8 million in the prior year period. Interest income of $8.8 million increased by $6.6 million from the $2.2 million recognized in the fourth quarter of 2012. The change was primarily due to the deployment of capital raised in February IPO and the acquisition of our mortgage loan portfolio, which increased interest income by $5.5 million. Other factors which increased interest income included increases in our average RMBS portfolio and average RMBS portfolio yield which raised interest income by 0.7 million and 0.4 million respectively.

We incurred interest expense of $3.1 million for the fourth quarter of 2013 compared with $0.3 million for the fourth quarter of 2012. The change of $2.8 million resulted from additional borrowings under the loan repurchase facility used to finance residential mortgage loans, security repurchase agreements and convertible notes.

As of December 31, 2013 the weighted average net interest spread between the yield on the Company’s assets and the cost of funds including the impact of interest rate hedging was 3.91% for mortgage loans and 4.61% for non-agency RMBS.

During the fourth quarter the Company recognized a favorable change in unrealized gain or loss on mortgage loans and real estate securities of $4.7 million as well as realized gains on mortgage loans and RMBS and gains on derivative instruments of $1.3 million.

We incurred operating expenses of $2.7 million for the fourth quarter of 2013 compared with $2.2 million for the fourth quarter of 2012. The increase in expenses was primarily due to several factors related to the Company’s IPO and transition to a public company. These factors included increases in professional fees, advisory fees and general and administrative expenses partially offset by a decrease in the interest on common stock repurchase liability.

Professional fees incurred -- increased by $0.8 million, primarily due to work performed by the independent orders for quarterly reviews and procedures performed for the 2013 annual financial statement audit. Advisory [in] fees increased by $0.6 million due to an increase in stockholders’ equity as a result of the Company’s February 2013 IPO.

General and administrative expenses increased by 0.5 million primarily due to transaction costs, insurance expense, research fees, trustee fees and independent directors fees.

Loan servicing fees increased by $0.5 million, due to the acquisition of home loans consistent with our investment strategy.

Increased expenses were partially offset by $1.8 million decrease in interest on common stock with purchase liability due to the repurchase of common stock in the first quarter of 2013.

That concludes our financial review; I’d now like to turn the call over to our Chief Investment Officer, Brian Hargrave to discuss our portfolio and investment activities.

Brian Hargrave

Thank you Paul and good morning everyone. As Mike discussed earlier, despite the Fed tapering announcement in December interest rates were relatively stable and volatility subdued during the fourth quarter. This interest rate environment was supportive of risk assets. Our whole loan and non-agency RMBS positions generated solid gains benefiting from the general market environment as well as from positive macro-economic fundamentals. While we have seen increased market volatilities subsequent to quarter end, mortgage credit markets remain constructive.

Our investment activity in the fourth quarter was somewhat limited with the addition of $41 million in non-agency RMBS during the quarter reflecting a partial investment of the proceeds from our note issuance. The fair value of our whole loan and non-agency RMBS positions stood at 331.8 million and 226.2 million respectively at December 31, 2013. This puts our capital allocation at approximately 54% to whole loans at year-end.

Going forward we expect to finish deployment of the convertible notes proceeds in early 2014 and continue to pursue opportunities to increase the allocation to whole loans throughout the remainder of the year.

At December 31st, we had a leverage ratio of 2.42 times with borrowings composed of 236.1 million outstanding under our loan repurchase facility used to finance residential mortgage loans, 138.6 million outstanding under repurchase agreement secured by our RMBS portfolio and 54.5 million book value of convertible notes outstanding.

The loan repurchase facility and repurchased agreements bear interest rates that have historically moved in close relationship to LIBOR. We continue to see ample opportunity to add borrowing capacity across both whole loans and RMBS. We have maintained some interest rate swap agreements to mitigate the effects of increases in interest rates for a portion of our outstanding repurchase agreement. These swap agreements provide for us to pay fixed interest rates and receive floating interest rates indexed of LIBOR effectively fixing the floating interest rates on $17.2 million of repurchased agreement borrowings as of December 31, 2013.

Our whole loan activity to-date has focused on higher risk performing and re-performing whole loans originated prior to the financial crisis. As this portfolio has begun to season on our balance sheet, we are pleased with its performance from a credit perspective. We continue to see this asset class as an attractive source of income and capital appreciation for our portfolio.

In addition we’ve continued to invest resources in our newly originated loan purchase program and expect to launch this initiative in the coming months. New regulations, a weak securitization market and lack of initiative on GSP reform all continue to post challenges for the non-agency lending market. However, we believe strongly in the long term opportunity set and we will continue to seek to position ZFC to benefit as that opportunity set evolves.

That concludes our prepared remarks and we can now open it up for questions.

Question-and-Answer Session


[Operator Instructions] And our first question comes from the line of Mike Widner with KBW. Please go ahead.

Mike Widner - Keefe, Bruyette & Woods, Inc.

Good morning guys. I was wondering if you could just maybe talk a little bit more about how we should think of leverage going forward in particularly just mechanics of the way that the convertibles flow through that. Should we still be thinking about 2.5 times leverages is it the right number or is it a higher number now with sort of the capital structure a little different?

Michael Szymanski

I think it probably will be a little different going forward I think we will -- given that that convertible is a little longer term and fixed rate we will probably target similar leverage at the asset level and then you have the additional leverage from the convert on top of that so I do think that that will increase and in some ways that convert will be treated more like equity from a capital standpoint.

Mike Widner - Keefe, Bruyette & Woods, Inc.

Okay, yes. So I mean that’s I guess the question and [indiscernible] because you guys talked about sort of not having fully deployed that yet which certainly to understand given the timing. But I guess just trying to figure out, you said it will be accretive to earnings. And so obviously carrying an 8% interest rate I think you need to have some leverage on there to get accretive to earnings. I am just trying to make sure that we fine tune the expectations properly going forward. I mean is what you’re saying to kind of treat it as equity and think of it as equity even though it gets mechanically calculated as debt for in the calculation?

Michael Szymanski

Yes I think that generally speaking how it will probably flow through.

Mike Widner - Keefe, Bruyette & Woods, Inc.

Okay, appreciate it. And then as far as the current allocation for all practical purposes you’re fairly close to 50-50. I mean do you have a preference in terms of which way it means going forward?

Michael Szymanski

I think we made a comment that we’ll look at opportunities to increase that allocation of whole loans. I think where we want to be a little opportunistic around that and do it where we think it’s sort of accretive and helps our overall positioning both from a return and risk standpoint, but I think our bias would be more towards increasing that allocation over time to loan specifically.


Thank you. [Operator Instructions] our next question comes from the line of Jim Young with West Family Investments. Please go ahead.

Jim Young - West Family Investments

Yes hi. As you completed your first year as a public company and you reflect upon the past year, what surprised you the most and if you could roll the clock back, what would you do differently?

Michael Szymanski

I’ll start off now and hand it off to Brian. I don’t know that we had many surprises. I think we said in previous calls we would have loved to have been able to deploy faster in the credit sensitive asset classes, specifically whole loans but realistically we met the targets that we laid out when we were out with the IPO by getting to that target allocation by the end of the third quarter. I think that we’re realistic about being a public company meaning that being a public company has a certain amount of expense related to it, so the important -- we firmly believe in what we’re doing, we see it every day, the differentiation and opportunities in secondary market whole loans, we’re feeling that there’re real opportunities in the newly originated space and we have all those capabilities lined up and we have clear strategies.

Our job is to continue to differentiate the stories you’ve seen in the marketplace so that the market understands it and that we ultimately grow, grow in scale and that we can absorb the cost of being a public company going forward, we’re committed to that and we’re very confident we’re going to be able to do that. In terms of portfolio construction, I am not sure -- I’ll hand it over to Brian.

Brian Hargrave

Yes, I don’t know that I have a lot to add to that, I think like Mike said we set a goal around ramping up the whole loan portfolio, we met that goal, would we have liked to done it quicker, sure. I think the Fed announcement in the middle of last year around that created the tapering expectation through a lot of turmoil into the market in general, so I feel like we were positioned as best we could and manage through that as best we could.

I guess the other thing I would comment on is maybe just build a little bit on Mike’s point is just, we -- I think where we’ve learned a lot is just around the investor communication process and when and, when we can and when we cannot speak with investors which is very different than the world we’re used to living on a private fund side, we’re kind of used to being able to have this open dialogue, so I think that we’re learning more around that, more investor relations part of it probably.

Jim Young - West Family Investments

Okay, thank you and speaking of expenses, Paul could you discuss a little bit on the -- out of the 2.7 million from professional fees, advisory, loan servicing, G&A, what are there, any of those expenses would you consider one time due to the IPO. I’m trying to get a sense as to what the normalized expense level looks like going into ‘14.

Paul McDade

Yes, the 2.7 that we saw obviously the numbers that we’re comparing to in our press release, the prior year quarter, we’re sort of comparing apples to oranges in the fact that the prior year quarter we were still a private entity and we did have one out of period adjustment with regard to the repurchase of common stock from one of our investors which added 1.8 million to the bottom line.

But you know the expenses that we see coming in the quarter of $2.7 million, they’re in line with expectations that management have for the quarter, so there are really no big surprises with regard to those expenses.

If we compare those expenses to the prior quarter, prior quarter, in the third quarter we had expenses of just about $3 million for the quarter, so we’re favorable by about $250,000, but if you look across the lines our professional fees you know again they reflect the cost of quarterly reviews by our accounting firm putting fees related to the 2013 financial statement audit and audit of our 10-K, we’ve also added expenses related to an internal audit function for the entity so those are in line with what management expected for the quarter.

Our advisory fees are in line with our -- the increase in the stockholders equity related to the IPO so that reflects the 1.5 -- the 150 basis points advisory fee that we collect.

The loan servicing fees, what you’re seeing here in the quarter is the first full quarter impact for loan servicing fees with regards to our portfolio. We did have [pools] that we had purchased in the third quarter so you’re seeing the full fourth quarter or full quarter impact of those loan servicing fees. And then our general and administrative expenses, you know, they’re because of, as Mike mentioned, running the public company we have insurance related costs, we have trustee fees, outside director fees, transaction cost related to [pools] etc. so that’s basically the story with regard to the expenses.

Jim Young - West Family Investments

Okay, then when you look at the, of the slide presentation that you put up on page 10, looks like the non-performers have been trending up from 100 basis points in June, 207 basis points at September and 310 in the December quarter. What does that trend look like going into this year and in the performing segment are there any issues we should be aware with respect to 30 days plus delinquent?

Unidentified company representative

No, to be clear this type of a loan portfolio where we’re buying current loans at a significant discount at par with a -- and the reason they’re priced there is that they have a lot of embedded credit risk and that’s something that we expect to be able to manage over time, but in that type of a portfolio you will see loans go delinquent, in some ways this portfolio, because we’re only buying current loans is positively selected and over time you’ll have loans that move into delinquency and if you look at our actual performance kind of versus our initial projections at the time of purchase, we don’t have -- it’s not a lot of data at this point. But we slightly outperformed kind of our baseline expectation. So you will continue to see, I would expect that performing/non-performing mix to move a little bit more towards non-performing. We do expect some amount of these ones will go into default. So I would say that there is nothing that we see that we're alarmed about there. But I would expect that trend to continue going forward.

Jim Young - West Family Investments

Again what I’m hearing is that the underlying credit trends are performing better than your expectations.

Michael Szymanski

Yes I think they are slightly better at this point, again not, we've owned this portfolio in aggregate now for a few months. So I wouldn’t be comfortable making a huge extrapolation from that, but just based on the numbers we look at which is really for this portfolio what we look at is that rate of migration into delinquency on a monthly basis, that’s kind of the key early indicator of any potential issues.

Jim Young - West Family Investments

Okay then lastly, when you think about your current quarterly dividend, your core earnings hasn’t covered that dividend to date, can you give a sense as to over what kind of a timeframe do you think that you’ll be able to cover the dividend on a core earnings basis?

Michael Szymanski

Yes, I think -- we kind of had the ramp up post IPO and the reallocation into loans and we really just finished that and then we did the convert issuance. So now I think we're kind of back into a little bit of a ramp up mode, albeit a much more condensed probably ramp up process. So you can see at the end of the year we didn’t have all of that capital allocated. So that allocation is going to drift into the first quarter. It won't -- so it will have a little bit of a carryover into the first quarter. But absent any other developments or activities, I would think that certainly as we get deeper into the first corner that will have kind of faded away at that point.


Our next question comes from the line of Douglas Harter with Credit Suisse; please go ahead.

Unidentified Company Representative

This is actually (indiscernible) sending in for Douglas Harter. Given the slowdown in the whole loan activity in the fourth quarter, can you guys comment on your pipeline and what you’re seeing in terms of pricing trends there?

Michael Szymanski

Yes, our slowdown in purchases was a really a conscious decision relative to kind of reaching our targeted equity allocation and then at that point becoming much more opportunistic about when we might reallocate capital of out of RMBS in to the whole loans. So I would say in general, the supply environment for loans has been quiet active as we come back to the beginning of the year.

And the pricing, I mean you can see in our results the pricing of our whole loan portfolio has gone up. That contributed to our gain. So that’s representative of the market, but we do think that there are attractive opportunities out there. The supply is relatively stable, and there is transparency into the forward supply, and we think that it’s a little -- I guess it’s a little more similar maybe not to how we would characterize the RMBS market where we still like security collection really matters in terms of generating forward returns. I think the loan market, you could argue, maybe a year ago it didn’t matter so much what you buy. It was just the fact that you bought something. Here I think we’re in an environment now where the selection of the assets you purchase is probably much more of a driver of returns going forward.


Thank you. And this concludes our question-and-answer session. I would like to turn the call back over to management for any closing remarks.

Michael Szymanski

Well once again thank you all for your participation today. And again we look forward to speaking with you on our next earnings call. Once again thank you so much.


Thank you, ladies and gentlemen, this does conclude our conference for today. If you would like to listen to the replay of today’s call, please dial 303-590-3030 or 1-800-406-7325 with access code 4669315. Thank you for your participation today. You may just now disconnect.

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