ZAIS Financial's (ZFC) CEO Michael Szymanski on Q1 2014 Results - Earnings Call Transcript

May.13.14 | About: ZAIS Financial (ZFC)

ZAIS Financial (NYSE:ZFC)

Q1 2014 Earnings Conference Call

May 13, 2014 10:00 a.m. ET

Executives

Scott Eckstein – Financial Relations Board

Michael Szymanski – CEO, President and Director

Paul McDade – CFO and Treasurer

Brian Hargrave – CIO

Analysts

Tapfuma Chibaya – Credit Suisse

Trevor Cranston – JMP Securities

Jim Young – West Family Investments

Operator

good morning ladies and gentlemen and thank you for standing by and welcome to the ZAIS Financial Corporation’s First Quarter 2014 Conference Call. During today’s presentation, all participants will be in a listen-only mode (Operator’s instructions). And as a reminder this call is being recorded today May 13, 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 first quarter and full year ended March 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 www.zaisfinancial.com. Additionally, a copy of the Company’s first 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 www.zaisfinancial.com. 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 and thanks for joining us today. We are pleased to present our financial results for the first quarter of 2014, which demonstrates the continuing execution of our mortgage credit focused investment strategy.

During this morning’s call, I’ll briefly discuss our financial results and other achievements during the quarter which include significant realized and unrealized gains in both our whole home loans and our non-agency RMBS portfolios. After that our CFO, Paul McDade, will review our financial results in more detail while our CIO, Brian Hargrave will discuss the mortgage credit market environment and recap our portfolio performance.

As noted today's press release for the first quarter 2014, we reported core earnings of 1.5 million or $0.17 per weighted average share outstanding. On the GAAP basis we reported net income of 2.5 million for the quarter or $0.28 per weighted average share outstanding. As stated in our press release our core and GAAP earnings for quarter were impacted by increased general administrative expenses as well as professional fees. These included an increase of approximately 0.9 million or $0.10 per share in general and administrative expenses largely attributable to due diligence cost and professional fees related to the company's evaluation of potential acquisition.

Increased professional fees of approximately 0.5 million or $0.06 per share included 2.2 million of accounting and legal work related to your recent registration statement filings.

During the first quarter we continue to execute on our whole loan strategy expanding our transaction mortgage loan portfolio to over 415 million of fair market value as of March 31st, 2014. In line with our investment strategy, our capital allocation to whole loan has increased to 67%.

Our securities portfolio at March 31st, 2014 has a fair amount of value of 231.8 million, up from December 31st, 2013 value of 226.2 million. Importantly we saw significant realized and unrealized gain in both whole loan and non-agency RMBS portfolios in the quarter.

As of March 31st, 2014, book value per share common stock and OP unit was $19.86 compared with $19.98 at December 31st, 2013.

The March 31st, 2014 book value includes 3.6 million or $0.40 per share of common stock and OP unit in dividend payable related to the previously announced March 20th, 2014 dividend declaration. This dividend was paid on April 14th, 2014 to stockholders and OP unit holders of record as of March 31st, 2014.

During the quarter, we also continued to develop our whole loan platform. We believe these efforts provide us the ability to further grow our legacy whole loan portfolio while also moving as closer to launching our new originated loan purchase program.

In summary, we continue to execute on our legacy whole loan investor strategy which is benefited supportive market conditions. We have been successful in deploying capital reaching our target allocation often ahead of schedule.

Our portfolio performance is in line or above our initial expectation and we continue to view this asset class which is telling us an opportunity.

And I will turn this call over to our Chief Manager Officer Paul McDade to review our financial performance.

Paul McDade

Thanks Mike good morning everyone. As Mike already mentioned for the quarter ended March 31, 2014 the Company reported GAAP net income of $2.5 million or $0.28 per weighted average share outstanding. Core earnings for the quarter were $1.5 million or $0.17 per weighted average share outstanding. The difference between GAAP and core earnings was due to net realized and unrealized gains of $1 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 previously noted in our release in past calls 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 $5.6 million for the first quarter of 2014, compared with $2.9 million in the prior year period. Interest income of $9.5 million increased by $6.1 million from the $3.4 million recognized in the first quarter of 2013. The change was primarily due to the deployment of capital raised in February 2013 IPO and the November 2013 issuance of the convertible notes which is now significantly allocated to whole loans.

The purchase of whole loans into the portfolio increased interest to income by $5.6 million. Other factors contributing to the increase in interest income included increases in the average RMBS portfolio yield and the purchase of other investment securities which raised interest income by $1 million and $0.1 million respectively.

These increases were partially offset by a decrease in the company's average RMBS portfolio balance which lower interest by $0.6 million.

We incurred interest expense of $3.9 million for the first quarter of 2014 compared with 0.5 million for the first quarter of 2013. The $3.4 million increase was from additional borrowings under the loan re purchase facility used to finance residential mortgage loans, security repurchase agreements and convertible notes.

As of March 31st, 2014, the weighted average net interest spread between the yield on a Company’s assets and the cost of funds including the impact of interest rate hedging was 3.97% for mortgage loans and 4.82% for non-agency RMBS and other investment securities.

During the first quarter the Company recognized a favorable change in unrealized gain or loss on mortgage loans and real estate securities and other investment securities of $3.8 million as well as realized gains on mortgage loans and RMBS of $0.3 million partially offset by losses on derivative instruments of $3.1 million.

We incurred operating expenses of $4.1 million for the first quarter of 2014 compared with $2.1 million in last year’s first quarter.

As mike mentioned earlier, general and administrative expenses increased by $0.9 million. This increase was mainly due to due-diligence cost and professional fees related to the evaluation of potential acquisition. Professional fees increased by $0.5 million due to procedures performed by the independent auditors for the 2013 annual financial statement audit and additional legal expenses related to company's registrations, statement filings, on Form S3.

The loan serving fees increased by 0.4 million than the prior year period due to the acquisition of whole loans as company executed on its investment strategy. Advisory fees increased by 0.2 million due to an increase in stockholder’s equity resulting from the company's February 2013 IPO.

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

Brian Hargrave

Thanks Paul and good morning everyone. In the first quarter of 2014, we experienced a rally in interest rates from the 2013 highs due primarily the perceive weakness in the economic environment. This weakness was confirmed with the recent first quarter GDP release estimating annualized growth of 0.1%.

At the same time, volatility in the fixed income markets continued to decline largely looking past the first quarter weakness. As a result market conditions remain quite supportive of risk assets. Our portfolio benefited from this environment with our whole loan and securities holdings generating realized and unrealized gains of $4.1 million for the quarter.

Despite the first quarter slowdown economic conditions seem to have improved meaningfully late in the first quarter and subsequent quarter end. Importantly, the housing market remains strong and continues to benefit from tight supply conditions.

Our investment activity in the first quarter included the deployment of force of proceeds from our November 2013 note issuance into both our whole loan and RMBS portfolios.

During the three months ended March 31st, 2014, we purchased mortgage loans with an unpaid principal balance of approximately $100.4 million resulting in whole loan portfolio fair market value of $415.6 million as of March 31st 2014. This puts our capital allocation at approximately 67% the whole loan at the end of the quarter.

We also acquired 14.5 million in non-agency RMBS and 10 million in other investments securities during the quarter which increased the fair value of our non-agency RMBS portfolio and other investment securities to 242.9 million at March 31st, 2014.

At March 31st, we had a leverage ratio of 2.9 times with borrowing composed of 297.4 million outstanding under our loan repurchase facility used to finance residential mortgage loans. $159.2 million outstanding under repurchase agreements secured by our RMBS portfolio and $54.8 million in book value of convertible notes outstanding.

During the quarter, we amended our loan repurchase facility to increase uncommitted funding by $75 million. The loan repurchase facility and repurchase agreements breaches that rates of historically moved in close relationship to LIBOR we are now in the negotiations with the counterparties and anticipate having additional available borrowing capacity from which we expect to be able to acquire additional assets going forward.

Additionally, we added an interest rate swaps during the first quarter of 2014 giving us the right but not the obligation to enter into a previously agreed upon swap contract on a future date. The notional amount of this option was $225 million as of March 31, 2014. Economically, this position gives us increased protection if rates start to move higher this year.

We have maintained some interest rates swap agreement to mitigate the effects of increases in interest rates for portion of our outstanding repurchase agreement. The swap agreement provide for us to pay fixed interest rates and receive floating interest rates in indexed of LIBOR effectively fixing the floating interest rate on 17.2 million of repurchase agreement borrowings as of March 31st, 2014.

Our whole loan portfolio strategy continues to be focused on a higher risk performing and re-performing whole loans originated prior to financial crisis. As we show our investors presentation available on our website, the portfolio has outperformed our expectations as measured by the movement of loans from current to delinquent status.

We continue to see this asset class as an attractive source of income and capital appreciation for our portfolio. In addition we have continued to develop our newly originated loan purchase program and are moving closer to launching this initiative.

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

Operator

Question-and-Answer Session

Thank you very much. [Operator Instruction] our first question comes from the line of Douglas Harter with Credit Suisse.

Tapfuma Chibaya - Credit Suisse

Thanks. Good morning guys this is actually Tapfuma on for Douglas Harter. I just want to go back to the expenses in the quarter, obviously elevated there with some one-time we saw that in the fourth quarter. So I just want to get a good sense of run rate going forward there is it just as simple as stripping out that 1.4 in total from the G&A professional fees?

Mike Szymanski

Yes to respond to that, first, we can't really give any type of a run-rate or perspective guidance on expenses but as you mentioned if we look at the expenses for the quarter and we normalize that the impact of the professional fees related to our S3 fillings and the professional fees in our G&A line items related to evaluation of the potential acquisition, we factored those million dollars of expenses out we have a normalized expense run rate for the quarter of about $3 million and those expenses are all in line with what you were expecting. We do have a little bit of chunky expense in the first quarter due to the fact that we have our annual financial statement audit that occurs and the bulk of all that work that's done on the audit because it's the substantial audit in nature all falls in the first quarter. So if you take those three factors I think the team is very comfortable with the expense run-rate factoring those normalization adjustment our of the expenses.

Tapfuma Chibaya - Credit Suisse

Got it. So just backing out all those expenses and looking at where you had deployed -- I think you said you're fully deployed at this point to get me closer to that $0.40 level, in terms of the core earnings power of the portfolio. Am I thinking about that right, at this point?

Mike Szymanski

Yes I think there is, two components to that, one is the expense piece that Paul covered and the other is the investment portfolio which we did continue to ramp-up during the quarter. It was fully ramped-up at the end of the quarter but it did ramp-up during the quarter. So I think you will have to factor both of those into the announcement.

Tapfuma Chibaya - Credit Suisse

Great. And just one last one if I may. In the other securities buckets, what type of investments do you have in that bucket there?

Mike Szymanski

Yes. That's $10 million of other investment securities is composed of risk transfer notes from one of the GSV risk transfer programs.

Tapfuma Chibaya - Credit Suisse

Great. Thanks guys.

Operator

And our next question does come from the line of Trevor Cranston with JMP Securities.

Trevor Cranston - JMP Securities

Hi, thanks. With respect to the potential acquisition you guys evaluated in the quarter, can you give any color on that if it was maybe an originator you guys were looking to buy and if so if that's something you guys would continue to look at going forward in order to start out on the newly originated loan business?

Mike Szymanski

Thanks so much. Let me give you some context and potential acquisitions. As our part of our business development activities, we look at a couple of potential acquisitions and we do this really opportunistically and I expect that we will continue to do that. And obviously, we can't give any assurance that we will identify any acceptable acquisition target or will be able to reach any agreement on the terms of any deal. And as a result we don't really – we don't give out specific acquisition criteria, we really look at each of the potential situation and we evaluate it as to whether or not it's going to fit within our business strategy and all of these things we look at from a complementary perspective to our organic business development activities, the things that we talk about in terms of legacy portfolio as well as newly originated opportunities But I am sure you can understand as a matter of policy, we cannot discuss any specific deal unless and until we come to a definite agreement and then we will make a public announcement. So, hopefully that gives you a little bit, it may not give a lot but that's our policy is really to be general in nature when we are looking at potential acquisitions.

Trevor Cranston - JMP Securities

Yes understood. And I appreciate those comments. If one other thing on the performing and re-performing loan side, can you guys just kind of comment on what you are seeing in the market right now if there has been any kind of trend towards more competition for assets or higher prices. I mean it looks like the yield on your portfolio was pretty stable this quarter. I am just curious about general market conditions.

Mike Szymanski

Yes I mean I think as you point out the yield on our portfolio has been relatively stable. We have over the last couple of quarters if you look back, generated games on that segment of the portfolio. So that segment portfolio is marked to market so that will give you a sense of what we have experienced on the price side. In terms of competition, I don't know if there is anything notable that I have noticed that changed there. I think the supply has been relatively stable and has met with reasonable demand I think that in large part the market has somewhat tracked the RMBS segment with varying degrees of lag over the last several months that would be my general comment.

Trevor Cranston - JMP Securities

Okay. That's helpful. The last thing on the book value roll-forward slide, you guys show a negative $0.35 on the derivative instruments which seems on the surface a little bit large relative to the swap and swaption book, can you just talk about what’s in that line item there this quarter.

Mike Szymanski

Yes that, I mean it is those two positions that are driving that loss and the majority of that is coming from the swaption on the quarter, that's the – it's a longer dated payer swaption. So as rates continue to rally and importantly as volatility continues to drop that position was hit accordingly.

I think we still are happy to have that position on and our – in many ways wanting to make sure that we are constantly mindful of the impact of higher rate on the portfolio.

Trevor Cranston - JMP Securities

Okay. So it's not they are correct way to look at it to see that if you didn’t have that swaption at the end of last quarter and March 31 had the positive fair value, you can't just take those two numbers and say that it looks like it was a positive mark in the quarter.

Mike Szymanski

I am not sure I understand the – you are right we didn’t have it at the end of last quarter. We acquired it during the quarter and then it generated a lot subsequent acquisition during the quarter.

Trevor Cranston - JMP Securities

Okay. I was on slide 19. I was looking at the fair value. It looks like it's positive $2 million. So that was all about.

Mike Szymanski

Yes, it was just less positive than it was in acquisition.

Trevor Cranston - JMP Securities

Got it. Okay. That makes sense. Thanks guys.

Mike Szymanski

Thank you.

Operator

And our next question does come from the line of Jim Young with West Family Investments.

Mike Szymanski

Hi, Jim.

Jim Young - West Family Investments

Yes, hi. You'd mentioned that, with the mortgage loans you acquired with unpaid principal balance of $100 million -- what were they acquired for in the quarter?

Mike Szymanski

Its approximately $85 million which if you think about on percentage of the unpaid principal balance, it's roughly in line with the price of our – marked to market value of our portfolio in general.

Jim Young - West Family Investments

And can you give us a sense of some of the credit characteristics on these mortgage loans and what kind of an IRR are you expecting from this portfolio?

Mike Szymanski

We can't really comment on perspective IRR, I guess. I think if you look at the -- and we haven’t disclose characteristics of that individual segment of portfolio. But I would guide you to is on our slide presentation slide nine, you can see the change and portfolio characteristics quarter-over -quarter and there is nothing really dramatic that leaps out of you. The average LTV drop a little bit, probably more due to home price appreciation and due to the acquisition the average credit score dropped more as a result of the acquisition but in large part the acquisition is very much in line with our existing portfolio from risk standpoint.

Jim Young - West Family Investments

Okay. Thank you.

Operator

At this time there are no further questions. I would like to turn the call back over to management for any closing comments.

Mike Szymanski

Well, thank you very much for joining us for our call today and we look forward to speaking with you on our next earnings call. Once again thank you very much.

Scott Eckstein

Thank you.

Operator

Ladies and gentlemen, that will conclude conference for today. If you would like to listen to the replay of this conference you may do so by dialing either 303-590-3030 or 1-800-406-7325. You will need to enter the access code of 4681154. Those telephone numbers once again are 303-590-3030 or 1-800-406-7325 with the access code 4681154. Again we do thank you for your participation on today’s call. You may now disconnect your lines at this time.

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