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EX-32.2 - EXHIBIT 32.2 - ZAIS Group Holdings, Inc.v471869_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - ZAIS Group Holdings, Inc.v471869_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - ZAIS Group Holdings, Inc.v471869_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - ZAIS Group Holdings, Inc.v471869_ex31-1.htm

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

  x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2017

 

  ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission file number: 001-35848

 

ZAIS GROUP HOLDINGS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware 46-1314400
(State or Other Jurisdiction of Incorporation or
Organization)
(I.R.S. Employer Identification No.)

 

Two Bridge Avenue, Suite 322

Red Bank, NJ 07701-1106

(Address of Principal Executive Offices and Zip Code)

 

(732) 978-7518
(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      Yes  x  No  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes  x  No  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨ Accelerated filer  ¨
   
Non-accelerated filer  ¨ Smaller reporting company  x
(Do not check if smaller reporting company)  
  Emerging growth company  x

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨ 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).       Yes  ¨  No x

 

As of August 14, 2017, 14,480,782 shares of Class A common stock, par value $0.0001 per share, and 20,000,000 shares of Class B Common Stock, par value $0.000001 per share, were issued and outstanding.

 

 

 

 

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION 3
   
Item 1. Financial Statements 3
   
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 48
   
Item 4. Controls and Procedures 74
   
PART II − OTHER INFORMATION 75
   
Item 1A. Risk Factors 75
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 75
   
Item 3. Defaults Upon Senior Securities 75
   
Item 4. Mine Safety Disclosures 75
   
Item 5. Other Information 76
   
Item 6. Exhibits 76
   
SIGNATURES 77

 

EXHIBIT 31.1  CERTIFICATIONS
 
EXHIBIT 31.2  CERTIFICATIONS
 
EXHIBIT 32.1  CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, 18 U.S.C. SECTION 1350
 
EXHIBIT 32.2  CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, 18 U.S.C. SECTION 1350

  

 2 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Financial Condition (Unaudited)
(Dollars in thousands, except share amounts)

 

   June 30, 2017   December 31, 2016 
         
Assets          
Cash and cash equivalents  $16,970   $38,712 
Income and fees receivable   1,869    8,805 
Investments in affiliates, at fair value   10,288    5,273 
Due from related parties   1,101    734 
Property and equipment, net   319    274 
Prepaid expenses   1,907    906 
Other assets   385    348 
Assets of Consolidated Funds          
Cash and cash equivalents   13,416    37,080 
Investments, at fair value   446,707    404,365 
Due from broker   12,095    16,438 
Other assets   1,007    1,210 
Total Assets  $506,064   $514,145 
           
Liabilities and Equity          
Liabilities          
Notes payable  $   $1,263 
Compensation payable   4,594    7,836 
Due to related parties   31    31 
Fees payable       2,439 
Other liabilities   1,147    1,127 
Liabilities of Consolidated Funds          
Notes payable of consolidated CLO, at fair value   384,519    384,901 
Due to broker   21,974    24,462 
Other liabilities   2,579    2,121 
Total Liabilities   414,844    424,180 
           
Commitments and Contingencies (Note 12)        
           
Equity          
Preferred Stock, $0.0001 par value; 2,000,000 shares authorized; 0 shares issued and outstanding.        
Class A Common Stock, $0.0001 par value; 180,000,000 shares authorized; 14,480,782 and 13,900,917 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively.   1    1 
Class B Common Stock, $0.000001 par value; 20,000,000 shares authorized; 20,000,000 shares issued and outstanding.        
Additional paid-in capital   64,210    63,413 
Retained earnings (Accumulated deficit)   (23,779)   (18,965)
Accumulated other comprehensive income (loss)   (44)   (70)
Total stockholders’ equity, ZAIS Group Holdings, Inc.   40,388    44,379 
Non-controlling interests in ZAIS Group Parent, LLC   19,417    22,258 
Non-controlling interests in Consolidated Funds   31,415    23,328 
Total Equity   91,220    89,965 
Total Liabilities and Equity  $506,064   $514,145 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 3 

 

  

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES
 
Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
(Dollars in thousands, except share and per share amounts)

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Revenues                    
Management fee income  $3,689   $3,571   $6,796   $7,140 
Incentive income   2,884    143    3,181    295 
Reimbursement revenue   383        877     
Other revenues   77    79    170    159 
Income of Consolidated Funds   404        404     
Total Revenues   7,437    3,793    11,428    7,594 
Expenses                    
Compensation and benefits   5,609    7,999    13,033    17,006 
General, administrative and other   3,879    2,950    7,548    6,160 
Depreciation and amortization   71    64    111    127 
Expenses of Consolidated Funds   30    29    73    48 
Total Expenses   9,589    11,042    20,765    23,341 
Other income (loss)                    
Net gain (loss) on investments   39    55    114    37 
Other income (expense)   32    87    16    692 
Net gain (loss) of Consolidated Funds’ investments   1,607    2,176    2,714    3,693 
Net gain (loss) on beneficial interest of collateralized financing entity   909        1,498     
Total Other Income (Loss)   2,587    2,318    4,342    4,422 
Income (loss) before income taxes   435    (4,931)   (4,995)   (11,325)
Income tax (benefit) expense   5    4    10    9 
Consolidated net income (loss), net of tax   430    (4,935)   (5,005)   (11,334)
Other comprehensive income (loss), net of tax:                    
Foreign currency translation adjustment   9    (147)   39    (201)
Total Comprehensive Income (Loss)  $439   $(5,082)  $(4,966)  $(11,535)
                     
Allocation of Consolidated Net Income (Loss), net of tax                    
Non-controlling interests in Consolidated Funds  $1,397   $1,052   $2,207   $1,786 
Stockholders’ equity, ZAIS Group Holdings, Inc.   (652)   (4,076)   (4,814)   (8,910)
Non-controlling interests in ZAIS Group Parent, LLC   (315)   (1,911)   (2,398)   (4,210)
 Total Allocation of Consolidated Net Income (Loss), net of tax  $430   $(4,935)  $(5,005)  $(11,334)
                     
Allocation of Total Comprehensive Income (Loss)                    
Non-controlling interests in Consolidated Funds  $1,397   $1,052   $2,207   $1,786 
Stockholders’ equity, ZAIS Group Holdings, Inc.   (646)   (4,174)   (4, 788)   (9,044)
Non-controlling interests in ZAIS Group Parent, LLC   (312)   (1,960)   (2,385)   (4,277)
 Total Allocation of Total Comprehensive Income (Loss)  $439   $(5,082)  $(4,966)  $(11,535)
                     
Consolidated Net Income (Loss), net of tax per Class A common share applicable to ZAIS Group Holdings, Inc. – Basic  $(0.05)  $(0.29)  $(0.34)  $(0.64)
Consolidated Net Income (Loss), net of tax per Class A common share applicable to ZAIS Group Holdings, Inc. – Diluted  $(0.05)  $(0.29)  $(0.34)  $(0.64)
                     
Weighted average shares of Class A common stock outstanding:                    
Basic   14,473,642    13,892,016    14,231,320    13,881,466 
Diluted   21,473,642    20,892,016    21,231,320    20,881,466 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 4 

 

 

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Changes in Equity and Non-controlling Interests (Unaudited)
(Dollars in thousands except share amounts)

 

Six Months Ended

June 30, 2017 

 

Class A

Common Stock

  

Class B

Common Stock

  

Additional

paid-in-capital

  

Retained
earnings

(Accumulated
deficit)

  

Accumulated

other

comprehensive

income

(loss)

  

Non-controlling

interests in

ZAIS Group
Parent, LLC

  

Non-controlling

interests in

Consolidated

Funds

   Total
Equity
 
   Shares   Amount   Shares   Amount                         
December 31, 2016   13,900,917   $1    20,000,000   $-   $63,413   $(18,965)  $(70)  $22,258   $23,328   $89,965 
Settlement of RSU awards   579,865    -    -    -    447    -    -    (447)   -    - 
Payment of employee taxes in connection with net settlement of RSUs                       (801)             -        (801)
Modification of equity awards to liability awards   -    -    -    -    (17)   -    -    (9)   -    (26)
Capital
contributions
   -    -    -    -    -    -    -    -    5,880    5,880 
Equity-based
compensation
charges
   -    -    -    -    1,168    -    -    -    -    1,168 
Consolidated
net income
(loss)
   -    -    -    -    -    (4,814)   -    (2,398)   2,207    (5,005)
Other comprehensive income (loss)   -    -    -    -    -    -    26    13    -    39 
June 30, 2017   14,480,782   $1    20,000,000   $-   $64,210   $(23,779)  $(44)  $19,417   $31,415   $91,220 

 

Six Months Ended
June 30, 2016 
  Class A
Common Stock
   Class B
Common Stock
  

Additional

paid-in-capital

  

Retained
earnings

(Accumulated
deficit)

  

Accumulated

other

comprehensive

income

(loss)

  

Non-controlling

interests in

ZAIS Group
Parent, LLC

  

Non-controlling

interests in

Consolidated

Funds

   Total
Equity
 
   Shares   Amount   Shares   Amount                         
December 31, 2015   13,870,917   $1    20,000,000   $-   $60,817   $(13,805)  $158   $23,716   $14,916   $85,803 
                                                   
Settlement of RSU awards   30,000    -    -    -    30    -    -    (30   -    - 
Capital contributions   -    -    -    -    -    -    -    -    4,907    4,907 
Capital distributions   -    -    -    -    -    -    -    (284)   -    (284)
Equity-based compensation charges   -    -    -    -    1,118    -    -    564    -    1,682 
Consolidated net income (loss)   -    -    -    -    -    (8,910)   -    (4,210)   1,786    (11,334)
Other comprehensive income (loss)   -    -    -    -    -    -    (134)   (67)   -    (201)
June 30, 2016   13,900,917   $1    20,000,000   $-   $61,965   $(22,715)  $24   $19,689   $21,609   $80,573 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 5 

 

 

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES
 
Consolidated Statements of Cash Flows (Unaudited)
(Dollars in thousands)

 

   Six Months Ended
June 30,
 
   2017   2016 
         
Cash Flows from Operating Activities          
Consolidated net income (loss)  $(5,005)  $(11,334)
Adjustments to reconcile consolidated net income (loss) to net cash provided by (used in) operating activities:          
Depreciation and amortization   111    127 
Net (gain) loss on investments   (114)   (37)
Non-cash stock-based compensation   1,168    1,682 
Interest expense on notes payable       4 
Operating cash flows due to changes in:          
Income and fees receivable   6,936    874 
Due from related parties   (367)   (634)
Prepaid expenses   (1,001)   (1,170)
Other assets   (27)   (1)
Compensation payable   (3,269)   728 
Due to related parties       (33)
Fees payable   (2,439)   (754)
Other liabilities   19    (748)
Proceeds from investments in affiliates   90     
Items related to Consolidated Funds:          
Purchases of investments and investments in affiliated securities   (295,989)   (10,000)
Change in unrealized (gain) loss on investments       (3,693)
Proceeds from sale of investments   201,635     
Proceeds from sale of beneficial interest of collateralized financing entity   54,262     
Net (gain) loss on investments   (4,130)    
Net gain (loss) on beneficial interest of collateralized financing entity   1,499     
Change in cash and cash equivalents   23,665    33 
Change in other assets   223     
Change in due from broker   4,343     
Change in due to broker   (2,488)    
Change in other liabilities   437     
Net Cash Provided by (Used in) Operating Activities   (20,441)   (24,956)
           
Cash Flows from Investing Activities          
Purchases of fixed assets   (152)   (17)
Distributions from investments in affiliates       87 
Purchases of investments in affiliates   (5,000)    
Purchases of investments, at fair value       (11)
Proceeds from sales of investments, at fair value       8,174 
Net Cash Provided by (Used in) Investing Activities   (5,152)   8,233 
           
Cash Flows from Financing Activities          
Contributions from non-controlling interests in Consolidated Funds   5,880    4,907 
Payment of employee taxes in connection with net settlement of RSUs   (801)    
Repayment of notes payable   (1,263)    
Distributions to non-controlling interests in ZGP       (284)
Net Cash Provided by (Used in) Financing Activities   3,816    4,623 
           
Net increase (decrease) in cash and cash equivalents denominated in foreign currency   35    (187)
Net increase (decrease) in cash and cash equivalents   (21,742)   (12,287)
Cash and cash equivalents, beginning of period   38,712    44,351 
Cash and cash equivalents, end of period  $16,970   $32,064 

  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 6 

 

 

 ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

1. Organization

 

ZAIS Group Holdings, Inc. (“ZAIS”, and collectively with its consolidated subsidiaries, as the context may require, the “Company”) is a holding company conducting substantially all of its operations through ZAIS Group, LLC (“ZAIS Group”), an investment advisory and asset management firm focused on specialized credit which commenced operations in July 1997 and is headquartered in Red Bank, New Jersey. ZAIS Group also maintains an office in London. ZAIS Group is a wholly-owned consolidated subsidiary of ZAIS Group Parent, LLC (“ZGP”), a majority-owned consolidated subsidiary of ZAIS. ZAIS is the managing member of ZGP.

 

ZAIS Group is registered with the SEC under the Investment Advisors Act of 1940 and with the Commodity Futures Trading Commission as a Commodity Pool Operator and Commodity Trading Advisor. ZAIS Group provides investment advisory and asset management services to private funds, separately managed accounts, structured vehicles (collateralized debt obligation vehicles and collateralized loan obligation vehicles, together referred to as “CLOs”) and, through October 31, 2016, ZAIS Financial Corp. (“ZFC REIT”), a publicly traded mortgage real estate investment trust (collectively, the “ZAIS Managed Entities”).

 

On February 15, 2017, the Board of Directors of the Company (the “Board of Directors”) established a Special Committee of independent and disinterested directors to consider any proposals by management or third parties for strategic transactions. The Board of Directors has been undertaking a strategic review of the Company’s business in order to enhance shareholder value, and has engaged a financial advisor for this purpose. Various alternatives have been and are being considered, including a possible sale or combination or other similar transaction, or a going private transaction which would result in the termination of the registration of ZAIS Class A common stock (“Class A Common Stock”) so as to cease periodic and other public company compliance and reporting. The Company has received from and provided to potential counterparties certain due diligence information. In addition, the Company’s management and financial advisor have held and expect to continue to hold preliminary discussions with potential counterparties and participants. There is no assurance that any of the preliminary discussions which have taken place or may in the future take place will result in any transaction or that any of the strategic alternatives under consideration will be implemented. The Company does not intend to provide periodic public updates on any of these matters except as required by law or regulation

 

The ZAIS Managed Entities predominantly invest in a variety of specialized credit instruments including corporate credit instruments such as CLOs, securities backed by residential mortgage loans, bank loans and various securities and instruments backed by these asset classes. ZAIS Group had the following assets under management (“AUM”):

 

Reporting Period  Approximately
(in billions)
 
As of June 30, 2017 (1)  $3.752 
As of December 31, 2016  $3.444 

 

(1) On April 19, 2017, the ZAIS Opportunity Fund, Ltd. received a redemption request for a redemption of approximately $68.3 million (value date of June 30, 2017) from a European investor impacted by regulatory constraints. This redemption is expected to be effectuated on August 31, 2017. The AUM amount presented has not been reduced for this redemption request.

 

ZAIS Group also serves as the general partner to certain ZAIS Managed Entities, which are generally organized as pass-through entities for U.S. federal income tax purposes.

 

 The Company’s primary sources of revenues are (i) management fee income, which is based predominantly on the net asset values of the ZAIS Managed Entities and (ii) incentive income, which is based on the investment performance of the ZAIS Managed Entities. Any management fee income and incentive income earned by ZAIS Group from the consolidated ZAIS Managed Entities (the “Consolidated Funds”) is eliminated in consolidation.

   

 7 

 

 

Additionally, a significant source of the Company’s revenues and other income is derived from income of Consolidated Funds, net gains of Consolidated Funds’ investments and net gains on beneficial interests in collateralized financing entities which invest in bank loans. A portion of income of Consolidated Funds and net gains of Consolidated Funds’ investments are allocated to non-controlling interests in Consolidated Funds.

 

2. Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited, interim, consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") as contained within the Financial Accounting Standards Board’s ("FASB") Accounting Standards Codification ("ASC") and the rules and regulations of the SEC for interim reporting. In the opinion of management, all adjustments considered necessary for a fair statement of the Company's financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for the interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP as contained in the ASC have been condensed or omitted from the unaudited interim condensed consolidated financial statements according to the SEC rules and regulations. The information and disclosures contained in these unaudited interim condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K. Certain comparative amounts in the consolidated financial statements have been reclassified to conform to the current period presentation.

 

Segment Reporting

 

The Company currently is comprised of one reportable segment, the investment management segment, and substantially all of the Company’s operations are conducted through this segment. The investment management segment provides investment advisory and asset management services to the ZAIS Managed Entities.

 

 Use of Estimates

 

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. While management believes that the estimates used in preparing the consolidated financial statements are reasonable and prudent, actual results may ultimately materially differ from those estimates.

 

Principles of Consolidation

 

The consolidated financial statements included herein are the financial statements of ZAIS, its subsidiaries and the Consolidated Funds. All intercompany balances and transactions are eliminated in consolidation, including ZAIS’s investment in ZGP and ZGP’s investment in ZAIS Group. The Company's fiscal year ends on December 31.

 

The consolidated financial statements include non-controlling interests in ZGP which is comprised of Class A Units of ZGP (“Class A Units”) held by Christian Zugel, the former managing member of ZGP and the founder and Chief Investment Officer of ZAIS Group, and certain related parties (collectively, the “ZGP Founder Members”).

 

The Company’s consolidated financial statements also include variable interest entities for which ZAIS Group is considered the primary beneficiary, and certain entities that are considered voting interest entities in which ZAIS Group has a controlling financial interest.

 

 8 

 

 

The Consolidated Funds include the following entities for the reporting periods presented:

 

    As of   Three Months Ended
June 30,
  Six Months Ended
June 30,
Entity   June 30,
2017
  December 31,
2016
  2017   2016   2017   2016
                         
ZAIS Zephyr A-6, LP (“Zephyr A-6”)   ü   ü   ü   ü   ü   ü
                         
ZAIS CLO 5, Limited
(“ZAIS CLO 5”)
  ü   ü   ü     ü  

 

The Consolidated Funds, except for consolidated CLOs, are deemed to be investment companies under U.S. GAAP, and therefore, the Company has retained the specialized investment company accounting of these consolidated entities in its consolidated financial statements. The economic interests which are held by third-party investors are reflected as non-controlling interests in Consolidated Funds.

 

 The Company has elected the fair value option for the assets and liabilities held by the Consolidated Funds that otherwise would not have been carried at fair value. See Notes 4 and 5 for further disclosure on the assets and liabilities of the Consolidated Funds for which the fair value option has been elected.

 

For consolidated CLOs, the Company uses the measurement alternative included in the collateralized financing entity guidance (the “Measurement Alternative”). The Company measures both the financial assets and financial liabilities of the consolidated CLO in its consolidated financial statements using the fair value of the financial assets of the consolidated CLO, which are more observable than the fair value of the financial liabilities of the consolidated CLO. As a result, the financial assets of the consolidated CLO are measured at fair value and the financial liabilities are measured in consolidation as: the sum of the fair value of the financial assets and the carrying value of any non-financial assets that are incidental to the operations of the CLO less (ii) the sum of the fair value of any beneficial interests retained by the reporting entity (other than those that represent compensation for services) and the Company’s carrying value of any beneficial interests that represent compensation for services. The resulting amount is allocated to the individual financial liabilities (other than the beneficial interest retained by the Company) using a reasonable and consistent methodology. Under the Measurement Alternative, the Company’s consolidated net income reflects the Company’s own economic interests in the consolidated CLO including changes in the (i) fair value of the beneficial interests retained by the Company and (ii) beneficial interests that represent compensation for collateral management services. Such changes are presented in Net gain (loss) on beneficial interest of collateralized financing entity in the Consolidated Statements of Comprehensive Income (Loss).

 

The majority of the economic interests in the CLOs are held by outside parties, and are reported as notes payable of consolidated CLOs in the consolidated financial statements. The notes payable issued by the CLOs are backed by diversified collateral asset portfolios consisting primarily of loans or structured debt. In exchange for managing the collateral for the CLOs, ZAIS Group may earn investment management fees, including, in some cases, subordinated management fees and contingent incentive fees. All of the management fee income, incentive income and Net gain (loss) on investments earned by ZAIS Group from the Consolidated Funds are eliminated in consolidation.

 

 9 

 

 

Reimbursement Revenue

 

ZAIS Group may pay research and data services expenses relating to the management of the ZAIS Managed Entities directly to vendors and may allocate a portion of these costs to the respective ZAIS Managed Entities per the terms of the related agreements (the “Research Costs”). These amounts may be reimbursable by the respective ZAIS Managed Entities and are recorded as Reimbursement revenue in the Consolidated Statements of Comprehensive Income (Loss) to the extent the Company is the primary obligor for such expenses and if the costs are charged back to the respective funds. The amounts for the three and six months ended June 30, 2016 were not material and therefore were not separately reported in the Consolidated Statements of Comprehensive Income (Loss).

 

Income of Consolidated Funds

 

Income of Consolidated Funds reflects the interest income recognized by Zephyr A-6 related to its investments in unconsolidated CLOs. Any discounts and premiums on fixed income securities purchased are accreted or amortized into income or expense using the effective interest rate method over the lives of such securities. The effective interest rates are calculated using projected cash flows including the impact of paydowns on each of the aforementioned securities.

 

Non-Controlling Interests

 

The non-controlling interests within the Consolidated Statements of Financial Condition may be comprised of (i) redeemable non-controlling interests reported outside of the permanent capital section when investors have the right to redeem their interests from a Consolidated Fund or ZAIS Group, (ii) equity attributable to non-controlling interests in Consolidated Funds (excluding CLOs) reported inside the permanent capital section when the investors do not have the right to redeem their interests and (iii) equity attributable to non-controlling interests in ZGP inside the permanent capital section, if applicable.

 

The Company records non-controlling interests in the Consolidated Funds (excluding CLOs) to reflect the economic interests in those funds held by investors other than interests attributable to ZAIS Group. Income allocated to non-controlling interests in ZGP includes the portion of management fee income received from ZFC REIT that was payable to holders of Class B interests in ZAIS REIT Management, LLC (“ZAIS REIT Management”), a majority owned subsidiary of ZAIS Group which was the external adviser to ZFC REIT prior to October 31, 2016 (see Note 6 – “Management Fee Income and Incentive Income”).

 

Recent Accounting Pronouncements

 

Since May 2014, the FASB has issued ASU Nos. 2014-09, 2015-14, 2016-08, 2016-10 and 2016-12, Revenue from Contracts with Customers. The objective of the guidance is to clarify the principles for recognizing revenue and supersedes most current revenue recognition guidance, including industry-specific guidance. The guidance is to be applied retrospectively to all prior periods presented or through a cumulative adjustment in the year of adoption, for interim and annual periods beginning after December 15, 2017. The Company currently recognizes incentive income subject to contingent repayment once all contingencies have been resolved. Whereas the new guidance requires an entity to recognize such revenue when it concludes that it is probable that a significant reversal in the cumulative amount of revenue recognized will not occur when the uncertainty is resolved. As such, the adoption of the new guidance may require the Company to recognize incentive income earlier than as prescribed under current guidance. The Company is currently evaluating the impact of adopting this new standard. 

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments─Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). The amendments, among other things, (i) requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (ii) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (iii) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) and (iv) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. ASU 2016-01 is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact of adopting this new standard. The adoption of ASU 2016-01 is not expected to have a material effect on the Company’s consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the balance sheet for those leases previously classified as operating leases. The amendments in ASU No. 2016-02 are effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period with early adoption permitted. The Company is currently evaluating the impact of adopting this new standard. 

 

 10 

 

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). This ASU addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early application is permitted, including adoption in an interim period. The adoption of ASU 2016-15 is not expected to have a material effect on the Company's consolidated financial statements.

  

In December 2016 the FASB issued ASU 2016-19, Technical Corrections and Improvements. As part of this guidance, ASU 2016-19 amends FASB ASC 820 to clarify the difference between a valuation approach and a valuation technique. The amendment also requires an entity to disclose when there has been a change in either or both a valuation approach and/or a valuation technique. ASU 2016-19 is effective on a prospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The Company has adopted ASU 2016-19 on its consolidated financial statements and disclosures. The adoption of ASU 2016-19 has not had a material impact on its consolidated financial statements.

 

3. Investments in Affiliates

 

In February 2017, ZAIS Group made a $5.0 million commitment to a ZAIS Managed Entity which focuses on investing in non-ZAIS managed CLOs, none of which has been called as of August 14, 2017.

 

In June 2017, ZAIS Group made a $5.0 million commitment to a ZAIS Managed Entity which carries first loss risk. ZAIS Group funded its entire $5.0 million commitment on June 29, 2017.

 

At June 30, 2017 and December 31, 2016, the Company held investments in six and five unconsolidated ZAIS Managed Entities (excluding an investment in a ZAIS Managed Entity for which no capital has been called as of August 14, 2017), respectively.

 

The Company applied the Fair Value Option to its investments in the ZAIS Managed Entities that are not consolidated. The Company believes that reporting the fair value of these investments is more indicative of the Company’s financial position than historical cost.

 

The fair value of these investments was as follows:

 

June 30,
2017
   December 31,
2016
 
(Dollars in thousands) 
        
$10,288   $5,273 

 

The Company recorded a change in unrealized gain (loss) associated with the investments still held at the end of each respective period as follows:

 

Three Months Ended   Six Months Ended 
June 30, 2017   June 30, 2016   June 30, 2017   June 30, 2016 
(Dollars in thousands) 
                  
$2   $25   $15   $(22)

 

Such amounts are included in Net gain (loss) on investments in the Consolidated Statements of Comprehensive Income (Loss).

 

At June 30, 2017 and December 31, 2016, no equity investment, individually or in the aggregate, held by the Company exceeded 20% of its total consolidated assets. Additionally, the Company did not have any income related to these investments, individually or in the aggregate, which exceeded 20% of its total Consolidated net income net of tax for the six months ended June 30, 2017 or June 30, 2016. As such, the Company did not present separate or summarized financial statements for any of its investees.

 

 11 

 

 

4. Fair Value Measurements

 

ASC 820 Fair Value Measurements defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements under U.S. GAAP. Specifically, this guidance defines fair value based on exit price, or the price that would be received upon the sale of an asset or the transfer of a liability in an orderly transaction between market participants at the measurement date. Fair value under U.S. GAAP represents an exit price in the normal course of business, not a forced liquidation price. If the Company was forced to sell assets in a short period to meet liquidity needs, the prices it receives could be substantially less than their recorded fair values.

 

The Company follows the fair value measurement and disclosure guidance under U.S. GAAP, which establishes a hierarchical disclosure framework. This framework prioritizes and ranks the level of market price observability used in measuring investments at fair value. Market price observability is affected by a number of factors, including the type of investment, the characteristics specific to the investment and the state of the marketplace including the existence and transparency of transactions between market participants. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices in an orderly market generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. In all cases, an instrument’s level within the hierarchy is based upon the market pricing transparency of the instrument and does not necessarily correspond to the Company’s perceived risk or liquidity of the instrument.

 

The Company considers observable data to be market data which is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided by independent sources that are actively involved in the relevant market. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the determination of which category within the fair value hierarchy is appropriate for any given investment is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires significant judgment and considers factors specific to the investment.

 

Assets and liabilities that are measured and reported at fair value are classified and disclosed in one of the following categories:

 

Level 1 — Fair value is determined based on quoted prices for identical assets or liabilities in an active market at measurement date. Assets and liabilities included in Level 1 include listed securities. As required in the fair value measurement and disclosure guidance under U.S. GAAP, the Company does not adjust the quoted price for these investments. The hierarchy gives highest priority to Level 1.

 

Level 2 — Fair value is determined based on inputs other than quoted prices that are observable for the asset or liability either directly or indirectly as of the reporting date. Assets and liabilities which are generally included in this category include corporate bonds and loans, less liquid and restricted equity securities and certain over-the-counter derivatives, including foreign exchange forward contracts whose values are based on the following:

 

  Quoted prices for similar assets or liabilities in active markets.

 

  Quoted prices for identical or similar assets or liabilities in non-active markets.

 

  Pricing models whose inputs are observable for substantially the full term of the asset or liability.

 

  Pricing models whose inputs are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability.

 

Level 3 — Fair value is determined based on inputs that are unobservable for the investment and includes situations where there is little, if any, market activity for the asset or liability. The inputs into the determination of fair value require significant management judgment or estimation and the Company may use models or other valuation methodologies to arrive at fair value. Investments that are included in this category generally include distressed debt, less liquid corporate debt securities, non-investment grade residual interests in securitizations, collateralized debt obligations and certain derivative contracts. The hierarchy gives the lowest priority to Level 3.

 

 12 

 

 

The Company has established a valuation process that applies for all levels of investments in the valuation hierarchy to ensure that the valuation techniques are consistent and verifiable. The valuation process includes discussions between the valuation team, portfolio management team and the valuation committee (the “Valuation Committee”). The Valuation Committee consists of senior members of ZAIS Group and is chaired by the Chief Financial Officer of ZAIS Group. The Valuation Committee meets to review and approve the results of the valuation process which are used in connection with the preparation of quarterly and annual financial statements. The Valuation Committee is responsible for oversight and review of the written valuation policies and procedures and ensuring that they are applied consistently.

 

The lack of an established, liquid secondary market for some of the Company’s holdings may have an adverse effect on the market value of those holdings and on the Company’s ability to dispose of them. Additionally, the public markets for the Company’s holdings may experience periods of volatility and periods of reduced liquidity and the Company’s holdings may be subject to certain other transfer restrictions that may further contribute to illiquidity. Such illiquidity may adversely affect the price and timing of liquidations of the Company’s holdings.

 

The following is a description of the valuation techniques used to measure fair value:

  

Investments in Bank Loans

 

The Company uses a nationally recognized pricing source to provide pricing for the bank loans held by the Consolidated Funds.

 

Investments in CLOs

 

ZAIS determined the fair value of the investments in CLOs generally with input from a third party pricing source. ZAIS verifies that the quotes received from the valuation source are reflective of fair value as defined in U.S. GAAP, generally by comparing trading activity for similar asset classes, pricing research provided by banks and brokers, indicative broker quotes and results from an external cash flows analytics tool.

 

Collateralized Loan Obligation – Warehouses

 

A Collateralized Loan Obligation Warehouse ("CLO Warehouse") is an entity organized for the purpose of holding syndicated bank loans, also known as leveraged loans, prior to the issuance of securities from that same vehicle.  During the warehouse period, a CLO Warehouse will secure investments and build a portfolio of primarily leveraged loans and other debt obligations. The warehouse period terminates when the collateralized loan obligation vehicle issues various tranches of securities to the market. At this time, financing through the issuance of debt and equity securities is used to repay the bank financing.

 

The fair value of a CLO Warehouse is determined by adding the excess spread (accrued interest plus interest received less financing cost) to the CLO Warehouse equity contribution made by the Consolidated Funds, unless ZAIS Group determines that the securitization will not be achieved, in which case, the fair value of a CLO Warehouse will be established based on the fair value of the underlying bank loan positions which are valued in a manner consistent with ZAIS Group’s valuation policy and procedures.  CLO warehouses can be exposed to credit events, mark to market changes, rating agency downgrades and financing cost changes. Changes in the fair value of a CLO Warehouse are reported in Net gain (loss) of Consolidated Funds’ investments in the Consolidated Statements of Comprehensive Income (Loss).

 

Investment in Affiliates

 

Under U.S. GAAP, the Company is permitted, as a practical expedient, to estimate the fair value of its investments in other investment companies using the net asset value (or its equivalent) of the related investment company. Accordingly, the Company utilizes the net asset value in valuing its investments in the unconsolidated ZAIS Managed Entities, which is an amount equal to the sum of the Company’s proportionate interest in the capital accounts of the affiliated entities at fair value. The fair value of the assets and liabilities of the ZAIS Managed Entities are determined by the Company in accordance with its valuation policies described above. Investments measured at fair value using the practical expedient are not required to be categorized within the fair value hierarchy. The resulting net gains or losses on investments are included in Net gain (loss) on investments in the Consolidated Statements of Comprehensive Income (Loss).

 

 13 

 

 

The valuation of the Company’s investments in unconsolidated ZAIS Managed Entities represents the amount the Company would receive at June 30, 2017 and December 31, 2016, respectively, if it were to liquidate its investments in these entities. ZAIS Group has the ability to liquidate its investments according to the provisions of the respective entities’ operative agreements.

 

Notes payable of Consolidated CLO

 

The fair value of notes payable of Consolidated CLO is determined by applying the Measurement Alternative.

 

The following tables summarize the Company’s assets and liabilities measured at fair value on a recurring basis within the fair value hierarchy levels or based on net asset values, as applicable:

 

   June 30, 2017 
   (Dollars in thousands) 
     
   Level 1   Level 2   Level 3   Net Asset
 Value
   Total 
Assets, at fair value:                         
Cash equivalents  $16,103   $   $   $   $16,103 
                          
Investments in affiliates, at fair value               10,288    10,288 
                          
Assets of Consolidated Funds                         
Investments, at fair value:                         
Bank loans           396,408        396,408 
CLOs:                         
Senior notes           18,998        18,998 
Mezzanine notes           3,950        3,950 
Subordinated notes           2,346        2,346 
Warehouse           25,005        25,005 
Total – investments, at fair value           446,707        446,707 
Total assets, at fair value  $16,103   $   $446,707   $10,288   $473,098 
                          
Liabilities, at fair value:                         
Liabilities of Consolidated Funds                         
Notes payable of Consolidated CLO, at fair value           384,519        384,519 
Total liabilities, at fair value  $   $   $384,519   $   $384,519 

  

 14 

 

 

   December 31, 2016 
   (Dollars in thousands) 
     
   Level 1   Level 2   Level 3   Net Asset
Value
   Total 
Assets, at fair value:                         
Cash equivalents  $36,971   $   $   $   $36,971 
                          
Investments in affiliates, at fair value               5,273    5,273 
Assets of Consolidated Funds                         
Investments, at fair value:                         
Bank loans           389,329        389,329 
CLOs:                         
Warehouse            15,036        15,036 
Total – investments, at fair value           404,365        404,365 
Total assets, at fair value  $36,971   $   $404,365   $5,273   $446,609 
                          
Liabilities, at fair value:                         
Liabilities of Consolidated Funds                         
Notes payable of Consolidated CLO, at fair value           384,901        384,901 
Total liabilities, at fair value  $   $   $384,901   $   $384,901 

  

The following tables summarize the changes in the Company’s Level 3 assets:

 

   Six Months Ended June 30, 2017 
   (Dollars in thousands) 
   Beginning
Balance
January 1,
2017
   Purchases/
Issuances
   Sales/
Redemptions/
Settlements
   Total
Realized
and
Change in
Unrealized
Gains
(Losses)
   Amortization
of Discounts/
Premiums
   Transfers
to (from)
Level 3
   Ending
Balance
June 30, 2017
   Change in
Unrealized
Gains/Losses
Relating to
Assets and
Liabilities
Still Held at
June 30,
2017
 
Assets:                                        
Bank loans  $389,329   $211,967   $(201,635)  $(3,939)  $686   $   $396,408   $(2,655)
CLOs:                                        
Senior notes       19,000        (106)   104        18,998    (106)
Mezzanine notes       3,950        (44)   44        3,950    (44)
Subordinated notes       6,072    (3,872)   113    33        2,346    (111)
Warehouse   15,036    55,000    (45,000)   (31)           25,005    (5)
Total investments, at fair value  $404,365   $295,989   $(250,507)  $(4,007)  $867   $   $446,707   $(2,921)
                                         
Liabilities:                                        
Notes payable of Consolidated CLO, at fair value  $384,901   $   $   $(382)   $   $   $384,519   $(382)
Total liabilities, at fair value  $384,901   $   $   $(382)   $   $   $384,519   $(382)

 

 15 

 

  

   Six Months Ended June 30, 2016 
   ( Dollars in thousands ) 
   Beginning
Balance
January 1,
2016
   Purchases/
Issuances
   Sales/
Redemptions/
Settlements
   Total
Realized
and
Change in
Unrealized
Gains
(Losses)
   Transfers
to (from)
Level 3
   Ending
Balance
June
30,
2016
   Change in
Unrealized
Gains/Losses
Relating to
Assets and
Liabilities
Still Held at
June 30,
2016
 
CLOs:                            
Warehouse  $30,509   $10,000   $   $3,692   $   $44,201   $3,692 
Total investments, at fair value  $30,509   $10,000   $   $3,692   $   $44,201   $3,692 

 

The Company’s policy is to record transfers between Level 1, Level 2 and Level 3, if any, at the beginning of the period. There were no transfers between Level 1, Level 2 and Level 3 during the six months ended June 30, 2017 or June 30, 2016.

 

The tables below summarize information about the significant unobservable inputs used in determining the fair value of the Level 3 assets and liabilities held by the Consolidated Funds:

 

Investment Type  Fair Value
at
June
30, 2017
   Valuation
Technique
  Unobservable
Input
  Amount/
Percentage
  Min   Max   Weighted
Average
 
   (Dollars in Thousands)                      
Assets of Consolidated Funds:                             
Bank loans  $396,408   Third party pricing source  Not
applicable
  Not applicable            
CLOs:                             
Senior notes   18,998   Third party pricing source  Not
applicable
  Not applicable            
Mezzanine notes   3,950   Third party pricing source  Not
applicable
  Not applicable            
Subordinated notes   2,346   Third party pricing source  Not
applicable
  Not applicable            
Warehouse   25,005   Cost plus excess spread  Excess
spread
  0.02%            
Total – Investments, at fair value  $446,707                         
                              
Liabilities of Consolidated Funds:                             
Notes payable of Consolidated CLO, at fair value  $384,519   Measurement Alternative  Not
applicable
  Not applicable            
Total – Notes payable of Consolidated CLO, at fair value  $384,519                         

 

 16 

 

 

 Investment Type  Fair Value
at
December
31, 2016
   Valuation
Technique
  Unobservable
Input
  Amount/
Percentage
  Min   Max   Weighted
Average
 
   (Dollars in Thousands)                      
Assets of Consolidated Funds:                             
Bank loans  $389,329   Third party valuation source  Not applicable  Not applicable            
CLOs:                             
Warehouse   15,036   Cost plus excess spread  Excess spread  0.2%            
Total – Investments, at fair value  $404,365                         
                              
Liabilities of Consolidated Funds:                             
Notes payable of Consolidated CLO, at fair value  $384,901   Measurement Alternative  Not applicable  Not applicable            
Total – Notes payable of Consolidated CLO, at fair value  $384,901                         

 

5. Variable Interest Entities

 

In the ordinary course of business, ZAIS Group sponsors the formation of variable interest entities (“VIEs”) that can be broadly classified into the following categories: hedge funds, hybrid private equity funds and CLOs. ZAIS Group generally serves as the investment advisor or collateral manager with certain investment-related, decision-making authority for these entities. The Company has not recorded any liabilities with respect to VIEs that are not consolidated.

 

 17 

 

 

Funds

 

The Company has determined that the fee it receives from several of the hedge funds and hybrid private equity funds ZAIS Group manages do not represent a variable interest, because ZAIS Group’s fee arrangements are commensurate with the level of effort performed and include only customary terms that do not represent variable interests. The Company considered investments its related parties have in these entities when determining if ZAIS Group’s fee represented a variable interest.

 

ZAIS Group owns 51% of a majority-owned affiliate, Zephyr A-6, which was formed to invest in collateralized loan obligation vehicles, including during the related warehouse period of such vehicles. The Company has determined that ZAIS Group is the primary beneficiary of Zephyr A-6 and therefore has consolidated Zephyr A-6 in its consolidated financial statements at June 30, 2017 and December 31, 2016 and for the three and six months ended June 30, 2017 and June 30, 2016. ZAIS Group is the primary beneficiary since it is deemed to have (i) the power to direct activities of the entity that most significantly impact its economic performance and (ii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the entity.

 

Zephyr A-6’s investments are as follows:

 

ZAIS CLO 5

 

ZAIS CLO 5, which priced on September 23, 2016 and closed on October 26, 2016, invests primarily in first lien senior secured bank loans and had a total capitalization of $408.5 million at the time of closing, which consisted of senior and mezzanine notes with an aggregate par amount of $368.0 million and subordinated notes of $40.5 million. The CLO matures in October 2028. In connection with the closing, Zephyr A-6 recognized a dividend of $8.8 million which represents gains that were realized under the terms of the CLO Warehouse agreement.

 

Zephyr A-6’s initial investment in ZAIS CLO 5 was $20.3 million ($20.5 million par), which represented approximately a 2.1% economic interest in the senior and mezzanine notes and approximately 31.8% economic interest in the subordinated notes. The Company determined that it is the primary beneficiary of ZAIS CLO 5 based on (i) its ability to impact the activities which most significantly impact ZAIS CLO 5’s economic performance as collateral manger and (ii) Zephyr A-6’s significant investment in the subordinated notes of ZAIS CLO 5. Therefore, the Company consolidated ZAIS CLO 5 in its financial statements at June 30, 2017 and December 31, 2016 and for the three and six months ended June 30, 2017.

 

In February 2017 Zephyr A-6 sold its interest in the Class A-1 tranche of ZAIS CLO 5 for a sales price of approximately $5.4 million and recognized a loss of approximately $81,000. Such amount is included in Net gain (loss) on beneficial interest of collateralized financing entity in the Consolidated Statements of Comprehensive Income (Loss).

 

Zephyr A-6 had an investment of $12.7 million and $19.5 million in ZAIS CLO 5, at fair value, at June 30, 2017 and December 31, 2016, respectively. These investments represent approximately a 0.6% economic interest in the senior and mezzanine notes and a 31.8% economic interest in the subordinated notes of ZAIS CLO 5 at June 30, 2017. These investments represent approximately a 2.1% economic interest in the senior and mezzanine notes and a 31.8% economic interest in the subordinated notes of ZAIS CLO 5 at December 31, 2016.

 

ZAIS CLO 5 was in the warehouse phase during the three and six months ended June 30, 2016 and continued to finance the majority of its loan purchases using its warehouse facility (the “ZAIS CLO 5 Warehouse Period”). The Company was not required to consolidate ZAIS CLO 5 during the ZAIS CLO 5 Warehouse Period.

 

ZAIS CLO 6, Limited (“ZAIS CLO 6”)

 

ZAIS CLO 6, which priced on May 3, 2017 and closed on June 1, 2017 (the “ZAIS CLO 6 Closing Date”), invests primarily in first lien senior secured bank loans and had a total capitalization of $512.0 million on the ZAIS CLO 6 Closing Date, which consisted of senior and mezzanine notes with an aggregate par amount of $460.0 million and subordinated notes of $52.0 million. The CLO matures in July 2029. In connection with the closing, Zephyr A-6 recognized a dividend of $2.7 million which represents gains that were realized under the terms of the CLO Warehouse agreement. Zephyr A-6’s initial investment of $29.0 million in ZAIS CLO 6 represented approximately a 5.0% economic interest in the senior and mezzanine note tranches and approximately a 13.5% economic interest in the equity tranche.

 

 18 

 

 

In May 2017 Zephyr A-6 sold a portion of its interest in the subordinated notes of ZAIS CLO 6 for a sales price of approximately $3.9 million and recognized a gain of approximately $223,500. Such amount is included in Net gain (loss) on beneficial interest of collateralized financing entity in the Consolidated Statements of Comprehensive Income (Loss).

 

Zephyr A-6’s investment in ZAIS CLO 6 was $25.3 million at fair value, at June 30, 2017 ($25.6 million par), which represented approximately a 5.0% economic interest in the senior, mezzanine and subordinated notes based on notional value. The Company determined that it is not the primary beneficiary of ZAIS CLO 6 based on Zephyr A-6’s minimal investment in the subordinated notes of ZAIS CLO 6. Therefore, the Company was not required to consolidate ZAIS CLO 6 in its financial statements at June 30, 2017 or for the three and six months ended June 30, 2017.

 

ZAIS CLO 6 was in the warehouse phase from its inception date through the ZAIS CLO 6 Closing Date (the “ZAIS CLO 6 Warehouse Period”). During this time ZAIS CLO 6 continued to finance the majority of its loan purchases using its warehouse facility. The Company was not required to consolidate ZAIS CLO 6 during the ZAIS CLO 6 Warehouse Period.

 

ZAIS CLO 7, Limited (“ZAIS CLO 7”)

 

ZAIS CLO 7 was formed in June 2017 and is in the warehouse phase at June 30, 2017. During the warehouse phase, ZAIS CLO 7 continues to finance the majority of its loan purchases using its warehouse facility (the “ZAIS CLO 7 Warehouse Period”).

 

Zephyr A-6 had an investment of $25.0 million in ZAIS CLO 7, at fair value, at June 30, 2017.

 

The Company was not required to consolidate ZAIS CLO 7 during the ZAIS CLO 7 Warehouse Period.

 

Net gain (loss) of Consolidated Funds’ Investments

 

Net gain (loss) related to Zephyr A-6’s investments in ZAIS CLO 5, ZAIS CLO 6 and ZAIS CLO 7 for the period which the investments were not consolidated by the Company includes the following: 

 

  

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
   2017   2016   2017   2016 
   (Dollars in thousands) 
ZAIS CLO 5:                    
Change in unrealized gain or loss  $   $2,176   $   $3,693 
                     
ZAIS CLO 6:                    
Change in unrealized gain or loss   (1,370)       (263)    
Realized gains   2,972        2,972     
Total – ZAIS CLO 6   1,602        2,709     
                     

ZAIS CLO 7:

                    
Change in unrealized gain or loss   5        5     
                     

Total – Net gain (loss) of Consolidated Funds’ investments

  $1,607   $2,176   $2,714   $3,693 

 

 19 

 

 

Securitized Structures

 

ZAIS Group and certain of its wholly owned subsidiaries act as collateral manager for CLOs that are VIEs. These CLOs are entities that issue collateralized notes which offer investors the opportunity for returns that vary commensurately with the risks they assume. The notes issued by the CLOs are generally backed by asset portfolios consisting of loans, other debt or other derivatives. For acting as the collateral manager for these structures, ZAIS Group receives collateral management fees comprised of senior collateral management fees, subordinated collateral management fees and incentive collateral management fees (subject to hurdle rates). In some cases, all of the collateral management fees are waived as a result of certain ZAIS Managed Entities owning equity tranches of the related CLO.

 

For CLOs in which the Company has no economic interests other than its fee arrangement, the Company has determined that the fee it receives from the CLOs does not represent a variable interest because ZAIS Group’s fee arrangements are commensurate with the level of effort performed and include only customary terms that do not represent variable interests. The Company considered investments its related parties have in the CLOs when determining if ZAIS Group’s fee represented a variable interest. The Company will continue to assess its investments in the CLOs to determine whether or not the Company is required to consolidate the CLOs in its financial statements.

 

The Dodd-Frank credit risk retention rules, which became effective on December 24, 2016, apply to any newly issued CLOs or certain cases in which an existing CLO is refinanced, issues additional securities or is otherwise materially amended. The risk retention rules specify that for each CLO, the relevant collateral manager must purchase and hold, unhedged, directly or through a majority-owned affiliate, either (i) 5% of the face amount of each tranche of the CLO’s securities, (ii) an amount of the CLO’s equity equal to 5% of the aggregate fair value of all of the CLO’s securities or (iii) a combination of the two for a total of 5%. The required risk must be retained until the latest of (i) the date that the CLO has paid down its securities to 33% of their original principal amount, (ii) the date that the CLO has sold down its assets to 33% of their original principal amount or (iii) the date that is two years after closing.

 

The Company determined that it is not the primary beneficiary of CLO Warehouses, which are VIEs, because the financing counterparty must approve all significant financing requests and, as a result, the Company does not have the power to direct activities of the entity that most significantly impacts its economic performance.

 

VIEs

 

 Consolidated VIEs 

 

At June 30, 2017 and December 31, 2016 the Consolidated Funds consist of Zephyr A-6 and ZAIS CLO 5. Both entities are VIEs.

 

The assets and liabilities of the consolidated VIEs are presented on a gross basis prior to eliminations in the tables in Note 16 – “Supplemental Financial Information” under the columns titled “Consolidated Funds.”

 

The assets presented belong to the investors in Zephyr A-6 and ZAIS CLO 5, are available for use only by the entity to which they belong and are not available for use by the Company. The Consolidated Funds have no recourse to the general credit of ZAIS Group with respect to any liability.

 

Unconsolidated VIEs

 

At June 30, 2017 and December 31, 2016, the Company’s unconsolidated VIEs consisted of the Company’s investments in certain ZAIS Managed Entities as well as the Consolidated Fund’s investments in certain collateralized financing entities.

 

 20 

 

 

The carrying amounts of the unconsolidated VIEs are as follows:

 

 

 

Investment In  Financial Statement
Line Item
  June 30,
 2017
   December 31,
2016
 
      (Dollars in thousands) 
Certain ZAIS Managed Entities  Investment in affiliates, at fair value  $288   $273 
CLOs  Assets of Consolidated Funds – Investments at fair value   25,294     
CLO Warehouses  Assets of Consolidated Funds – Investments at fair value   25,005    15,036 
   Total  $50,587   $15,309 

 

 Such amounts are included in the Consolidated Statements of Financial Condition.

 

ZAIS Group has a minimal direct ownership, if any, in the unconsolidated VIEs and its involvement is generally limited to providing asset management services. ZAIS Group’s exposure to loss from these entities is limited to a decrease in the management fee income and incentive income that has been earned and accrued, as well as any change in fair value of its direct equity ownership in the VIEs.

 

Zephyr A-6, one of the Consolidated Funds, contributed the following amounts to ZAIS CLO 5, ZAIS CLO 6 and ZAIS CLO 7 during the warehouse periods: 

 

  

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
   2017   2016   2017   2016 
   (Dollars in thousands) 
                 
ZAIS CLO 5  $   $   $   $10,000 
ZAIS CLO 6           30,000     
ZAIS CLO 7   25,000        25,000     
Total  $25,000   $   $55,000   $10,000 

 

Notes Payable of Consolidated CLO

 

Notes payable of ZAIS CLO 5, the consolidated CLO, are collateralized by the assets held by the ZAIS CLO 5. This collateral primarily consists of bank loans.

 

The fair value of the assets and liabilities of ZAIS CLO 5 and the eliminations for the Consolidated Fund’s investment in ZAIS CLO 5 are as follows:

 

   June 30,
2017
   December 31,
2016
 
   (Dollars in thousands) 
Cash and cash equivalents  $12,634   $23,987 
Investments, at fair value   396,407    389,329 
    409,041    413,316 
           
Other assets (liabilities), net   (11,488)   (8,909)
Notes payable of consolidated CLO, at fair value   397,553    404,407 
Elimination of Consolidated Funds’ investments in CLO   (13,034)   (19,506)
Notes payable of consolidated CLO, at fair value (net of eliminations)  $384,519   $384,901 

 

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The Company has elected to carry these notes at fair value in its Consolidated Statements of Financial Condition. Accordingly, the Company measured the fair value of the notes payable (as a group including both the senior and subordinated notes) as (1) the sum of the fair value of the financial assets and the carrying value of any non-financial assets, less (2) the sum of the fair value of any beneficial interests retained by the Company (other than those that represent compensation for services) and the Company’s carrying value of any beneficial interests that represent compensation for services. The Company allocated the resulting amount to the different classes of notes based on the CLO’s waterfall on an as liquidated basis.

 

 The tables below present information related to ZAIS CLO 5’s notes payable outstanding. The subordinated notes have no stated interest rate, and are entitled to any excess cash flows after contractual payments are made to the senior notes.

 

   June 30, 2017
   (Dollars in thousands)
                    
   Unpaid 
Principal
Outstanding
   Fair
Value
   Weighted
Average
Interest
Rate
   Weighted
Average
Maturity
(in Years)
   Stated
Maturity
Dates
Senior and Mezzanine Secured Notes  $365,745   $357,507    3.35%   11.33   October 2028
Subordinated Notes   27,635    27,012    N/A    11.33   October 2028
Total  $393,380   $384,519              

   

   December 31, 2016
   (Dollars in thousands)
                    
   Unpaid 
Principal
Outstanding
   Fair
Value
   Weighted
Average
Interest
Rate
   Weighted
Average
Maturity
(in Years)
   Stated
Maturity
Dates
Senior and Mezzanine Secured Notes  $360,395   $357,489    2.97%   11.83   October 2028
Subordinated Notes   27,635    27,412    N/A    11.83   October 2028
Total  $388,030   $384,901              

 

6. Management Fee Income and Incentive Income

 

ZAIS Group earns management fees for the funds and accounts which are generally based on (i) the net asset value of these funds and accounts prior to the accrual of incentive fees/allocations or (ii) drawn capital during the investment period.

 

Management fee income earned for the CLOs which ZAIS Group manages are generally based on the par value of the collateral and cash held in the CLOs. Additionally, subordinated management fees may be earned from CLOs for which ZAIS Group and certain of its wholly owned subsidiaries act as collateral manager. The subordinated management fee is an additional payment for the same collateral management service, but has a lower priority in the CLOs’ cash flows and is contingent upon the economic performance of the respective CLO. If the CLOs experience a certain level of asset defaults, these fees may not be paid. There is no recovery by the CLOs of previously paid subordinated fees.

 

Prior to October 31, 2016, ZAIS Group earned management fee income from ZFC REIT, quarterly, based on ZFC REIT's stockholders' equity, as defined in the amended and restated investment advisory agreement between ZAIS REIT Management and ZFC REIT. Twenty percent of the management fee income received from ZFC REIT was paid to holders of Class B interests in ZAIS REIT Management. The payment to the Class B interests in ZAIS REIT Management was recorded as distributions to non-controlling interests in ZAIS Group Parent, LLC. The income was recorded as Management fee income in the Consolidated Statements of Comprehensive Income (Loss), and the portion of the management fees allocated to the holders of Class B interests in ZAIS REIT Management was included in the Allocation of Consolidated Net Income (Loss) to Non-controlling interests in ZAIS Group Parent, LLC. On October 31, 2016, the management agreement with ZFC REIT was terminated upon the completion of the merger between ZFC REIT and Sutherland Asset Management Corp (the “Termination Agreement”). Pursuant to the Termination Agreement, ZAIS REIT Management received a termination payment in the amount of $8.0 million.

 

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Management fees are generally collected on a monthly or quarterly basis.

 

ZAIS Group manages certain ZAIS Managed Entities from which it may earn incentive income based on hedge fund-style and private equity-style fee arrangements. ZAIS Managed Entities with hedge fund-style fee arrangements are those that pay ZAIS Group, on an annual basis, an incentive fee/allocation based on a percentage of net realized and unrealized profits attributable to each investor, subject to a hurdle (if any) set forth in each respective entity’s operative agreements. Additionally, all ZAIS Managed Entities with hedge fund-style fee arrangements are subject to a perpetual loss carry forward, or a perpetual “high-water mark,” meaning that the relevant ZAIS Managed Entity will not pay incentive fees/allocations with respect to positive investment performance generated for an investor in any year following negative investment performance until that loss is recouped, at which point an investor’s capital balance surpasses the high-water mark. ZAIS Managed Entities with private equity-style fee arrangements are those that pay an incentive fee/allocation based on a priority of payments under which investor capital must be returned and a preferred return must be paid, as specified in each related ZAIS Managed Entity’s operative agreement, to the investor prior to any payments of incentive-based income to ZAIS Group. For CLOs, incentive income is earned based on a percentage of cumulative profits, subject to the return of contributed capital, payment of subordinate management fees (if any) and a preferred inception to date return as specified in the respective CLOs’ collateral management agreements. The advisory agreement between ZAIS REIT Management and ZFC REIT did not provide for incentive fees.

  

The following tables represent the gross amounts of management fee income and incentive income earned prior to eliminations due to consolidation of the Consolidated Funds and the net amount reported in the Company’s Consolidated Statements of Comprehensive Income (Loss):

 

     

Three Months Ended

June 30, 2017

 
      ( Dollars in thousands ) 
   Fee Range  Gross
Amount
   Elimination   Net
Amount
 
Management Fee Income (1)                  
Funds and accounts   0.50% - 1.25%  $2,745   $(329)  $2,416 
CLOs   0.15% - 0.50%   1,273        1,273 
Total     $4,018   $(329)  $3,689 
                   
Incentive Income (1) (2)                  
Funds and accounts   10% - 20%  $2,784   $   $2,784 
CLOs  20%   100        100 
Total     $2,884   $   $2,884 

 

     

 Three Months Ended

June 30, 2016

 
      (Dollars in thousands) 
   Fee Range  Gross
Amount
   Elimination   Net
Amount
 
Management Fee Income (1)                  
Funds and accounts  0.50% - 1.25%  $2,373   $   $2,373 
CLOs  0.15% - 0.50%   425        425 
ZFC REIT(3)  1.50%   773        773 
Total     $3,571   $   $3,571 
                   
Incentive Income (1) (2)                  
Funds and accounts  10% - 20%  $143   $   $143 
CLOs  20%            
Total     $143   $   $143 

 

 23 

 

 

     

Six Months Ended

June 30, 2017

 
      ( Dollars in thousands ) 
   Fee Range  Gross
Amount
   Elimination   Net
Amount
 
Management Fee Income (1)                  
Funds and accounts  0.50% - 1.25%  $5,358   $(329)  $5,029 
CLOs  0.15% - 0.50%   1,767        1,767 
Total     $7,125   $(329)  $6,796 
                   
Incentive Income (1) (2)                  
Funds and accounts  10% - 20%  $3,071   $   $3,071 
CLOs  20%   110        110 
Total     $3,181   $   $3,181 

 

     

Six Months Ended

June 30, 2016

 
      (Dollars in thousands) 
   Fee Range  Gross
Amount
   Elimination   Net
Amount
 
Management Fee Income (1)                  
Funds and accounts  0.50% - 1.25%  $4,769   $   $4,769 
CLOs  0.15% - 0.50%   830        830 
ZFC REIT(3)  1.50%   1,541        1,541 
Total     $7,140   $   $7,140 
Incentive Income (1) (2)                  
Funds and accounts  10% - 20%  $295   $   $295 
CLOs  20%            
Total     $295   $   $295 

 

  (1) Certain management and incentive fees have been and may in the future be waived and therefore the actual fees rates may be lower than those reflected in the range.

 

  (2) Incentive income earned for certain of the ZAIS Managed entities is subject to a hurdle rate of return as specified in each respective ZAIS Managed Entity’s operative agreement.

 

  (3) On October 31, 2016, the management agreement with ZFC REIT was terminated pursuant to the Termination Agreement.

 

 24 

 

 

The Company may give credits for management fee income and/or incentive income to investors which invest in ZAIS Managed Entities that invest in other ZAIS Managed Entities where fees are also charged. The Company recorded all credits relating to management fee income and incentive income as Fees payable in the Consolidated Statements of Financial Condition and a reduction of either Management fee income or Incentive income in the Consolidated Statements of Comprehensive Income (Loss). The management fee income and incentive income amounts above are net of the following credits:

 

  

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
   2017   2016   2017   2016 
   (Dollars in thousands) 
                 
Management fee income credit  $63   $50   $126   $104 
Incentive income credit                
Total  $63   $50   $126   $104 

 

Zephyr A-6 invests in certain CLOs managed by ZAIS. ZAIS earns fees from these CLOs. Any Senior Fee in excess of 0.15%, the Subordinate Fee and the Incentive Fee (collectively, the “Rebated Fees”) paid to the Company by these CLOs are subsequently paid to Zephyr A-6 by the Company and allocated among the limited partners of Zephyr A-6 pro rata based on their percentage interests in Zephyr A-6. As a result of its interest in Zephyr A-6, ZAIS is allocated a substantial portion of the Rebated Fees. The fee rebate income and related expense are eliminated in consolidation. The amounts allocable to the non-ZAIS partner of Zephyr A-6 are included in Non-controlling interest in Consolidated Funds in the Consolidated Statements of Comprehensive Income (Loss).

 

The following table presents the gross amount of the rebated fees prior to eliminations due to the consolidation of Zephyr A-6 and the net amount reported in the Company’s Consolidated Statements of Comprehensive Income (Loss):

 

  

Three and Six Months Ended

June 30, 2017

 
   ( Dollars in thousands ) 
   Gross
Amount
   Elimination   Net
Amount
 
Rebated Fees  $290   $(290)  $ 
Total  $290   $(290)  $ 

 

Management fee income and incentive income which was accrued, but not received is as follows:

 

   June 30,
2017
   December 31,
2016
 
   (Dollars in thousands) 
         
Management fee income  $1,278   $1,284 
Incentive income   591    7,521 
Total  $1,869   $8,805 

 

Such amounts are included in Income and fees receivable in the Consolidated Statements of Financial Condition.  

 

The Company did not recognize any bad debt expense for the three and six months ended June 30, 2017 or June 30, 2016. The Company believes all income and fees receivable balances are fully collectible.

 

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7. Notes Payable

 

On March 17, 2015, in conjunction with the contribution of cash by HF2 Financial Management, Inc. to ZGP in exchange for newly issued Class A Units, representing a majority financial interest in ZGP (the “Business Combination”), ZAIS issued two promissory notes with an aggregate principal balance of $1.25 million to EarlyBirdCapital, Inc. and Sidoti & Company, LLC. The notes accrued interest at an annual rate equal to the annual applicable federal rate as published by the Internal Revenue Service (“AFR”) until the principal amount of, and all accrued interest on, the notes were paid in full. The notes matured on March 17, 2017 at which time the principal balance and accrued interest was paid in full. The notes were issued in lieu of paying certain underwriting costs at the closing of the Business Combination and, accordingly, treated as a direct cost attributable to the Business Combination and capitalized to equity.

 

The carrying amount of the Company’s notes payable approximates their fair value at December 31, 2016.

 

Total interest expense is included in Other income (expense) in the Consolidated Statements of Comprehensive Income (Loss) and was as follows:

 

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$   $2   $3   $4 

 

8. Compensation

 

The following table presents a detailed breakout of the Company’s compensation expense:

 

  

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
   2017   2016   2017   2016 
   (Dollars in thousands) 
                 
Salaries  $2,293   $2,593   $4,629   $5,873 
Bonus   2,966    3,502    6,143    7,400 
Severance       119    72    762 
Equity-Based Compensation   56    1,339    1,168    1,682 
Payroll taxes and benefits   294    443    1,021    1,286 
Commissions       3        3 
Total  $5,609   $7,999   $13,033   $17,006 

 

A summary of the Company’s compensation arrangements are as follows:

 

Bonus

 

Incentive Cash Compensation

 

Employees are eligible to receive discretionary incentive cash compensation (the “Bonus Award”) on an annual basis and certain employees may also be eligible to receive guaranteed incentive compensation (the “Guarantees”). The amount of the Bonus Award is based on, among other factors, both individual performance and the financial results of ZAIS Group. For certain employees, as documented in an underlying agreement (the “Bonus Agreements”), the Bonus Award may be further subject to a retention-based payout schedule that generally provides for 30% of the Bonus Award to vest and be paid incrementally over a three-year period. The Company expenses all current cash incentive compensation award payments ratably in the first year. All future payments are amortized equally over the required service period over the remaining term of the Bonus Award as defined in the Bonus Agreements. Any Guarantees that are paid upon an employee commencing employment are expensed immediately by the Company. All future payments related to Guarantees are amortized equally over the required service period over the remaining term as defined in the agreements for the Guarantees (“Guarantee Agreement”). In the event an award is forfeited pursuant to the terms of the Bonus Agreement or Guarantee Agreement, the corresponding accruals will be reversed.

 

 26 

 

 

Levels of incentive compensation will vary to the extent they are tied to the performance of certain ZAIS Managed Entities or the financial and operating performance of the Company. The compensation payable balance includes accrued incentive compensation and severance.

 

During the period from January 1, 2017 through June 30, 2017, the Company paid approximately $9.0 million related to year-end Bonus Awards issued in 2016, Bonus Awards that vested through February of 2017 pursuant to the Bonus Agreements related to a prior year and Guarantees that vested through February 2017 pursuant to Guarantee Agreements related to a prior year and the current year. A portion of these amounts had been accrued at December 31, 2016.

 

On May 9, 2017, the Board of Directors approved an amendment to the Compensation Committee’s charter to better enable the Company to retain its employees and to attract additional employees. The amendment removed the prior compensation guidelines set forth in the charter that by its terms applied to compensation paid through 2019. These compensation guidelines had provided that, subject to modification or waiver by the Compensation Committee, the Company’s total compensation expense on a consolidated basis calculated in accordance with U.S. GAAP for all cash and non-cash compensation paid to employees of the Company and its operating subsidiaries and affiliates for any given year would not exceed a certain percentage of the Company’s consolidated revenue for such year calculated in accordance with U.S. GAAP.

 

Retention Payment Plan

 

On March 29, 2016, the Compensation Committee of the Board of Directors adopted a retention payment plan for certain employees of ZAIS Group (the "Retention Payment Plan"). The Retention Payment Plan applied to approximately 60 employees of ZAIS Group all of whom had an annual base salary of less than $300,000. The purpose of the Retention Payment Plan was to enable ZAIS Group to retain the services of its employees in order to ensure that ZAIS Group was not disrupted or adversely affected by the possible loss of personnel or their commitment to ZAIS Group. Under the Retention Payment Plan, the participating employees were entitled to receive cash retention payments on each of April 15, 2016, August 15, 2016 and November 15, 2016, if the employee remained employed by ZAIS Group on such dates. The Company paid an aggregate amount of approximately $4.6 million to all participants pursuant to the Retention Payment Plan during the year ended December 31, 2016.

 

There were no amounts payable under the Retention Payment Plan at June 30, 2017 or December 31, 2016.

 

Other

 

On March 1, 2016, the Compensation Committee of the Board of Directors approved a retention payment of $900,000 to Howard Steinberg, the Company's former General Counsel, which was paid on March 15, 2016. This retention payment is included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss) for the six months ended June 30, 2016.

 

On April 5, 2017, the Company provided a retention award (the “Retention Award”) to Michael Szymanski, the Company’s Chief Executive Officer in recognition of the importance of retaining his services as the Chief Executive Officer of the Company and its operating subsidiary, ZAIS Group, and in connection with the Company’s review of strategic alternatives to enhance shareholder value. Under the Retention Award, which has been approved by the Compensation Committee of the Board of Directors of the Company, Mr. Szymanski is entitled to receive a cash retention payment of $500,000 on each of June 30, 2017, September 30, 2017 and a date within five business days following the closing date of a “Transaction” as defined in the Retention Award or otherwise as determined by the Board of Directors of the Company. Mr. Szymanski would be entitled to such payments provided he remains employed by the Company on such dates, or if he has been removed as the Company’s Chief Executive Officer or his employment terminated for reasons other than for cause prior to such dates. The aggregate amount of retention payments that may be paid to Mr. Szymanski under the Retention Award is $1.5 million. 

 

 27 

 

 

Points

 

ZAIS Group had entered into agreements with certain of its employees whereby certain current and former employees were granted rights to participate in a portion of the incentive income received from certain ZAIS Managed Entities (referred to as “Points Agreements”). There are currently outstanding Points Agreements relating to one ZAIS Managed Entity and ZAIS Group does not anticipate awarding additional Points Agreements. The Company did not incur any compensation expense relating to the Points Agreements for the three or six months ended June 30, 2017 or June 30, 2016.

 

Severance

 

On March 8, 2016, the Company commenced a reduction in force which resulted in a decrease of 23 employees of ZAIS Group. The Company had incurred total severance charges of approximately $762,000 related to this reduction in force which was recognized and paid during the year ended December 31, 2016.

 

Equity-Based Compensation

 

Class B-0 Units

 

ZGP authorized 1,600,000 Class B-0 Units eligible to be granted to certain employees of ZAIS Group. The Class B-0 Units were subject to a two year cliff-vesting provision, whereby all Class B-0 Units granted to an employee would be forfeited if the employee resigned or was terminated prior to March 17, 2017. Subsequent to this date, an employee would only forfeit vested Class B-0 Units if the employee was terminated for cause. Until the time that such Class B Units became vested, the Class B-0 Units were not entitled to any distributions from ZGP (and thus would not participate in, or be allocated any, income or loss) or other material rights. Upon vesting, the Class B-0 Units would have had the same rights as Class A Units and were exchangeable on a one for one basis for shares of Class A Common Stock or cash (or a combination of shares and cash), at the Company’s election, subject certain restrictions. This compensation expense was amortized equally over the two-year vesting period and was cumulatively adjusted for changes in estimated forfeitures at each reporting date.

 

On December 1, 2016, the Board of Directors authorized ZGP to offer the 28 employees holding unvested Class B-0 Units the right to receive in consideration for the cancellation of their Class B-0 Units, at the holder’s option, either (a) Restricted Stock Units (“RSUs”) of ZAIS, on a one-for-one basis, or (b) an amount of cash per Class B-0 Unit cancelled (the “Cash Amount”) equal to $1.92, which was the average of the daily closing prices of Class A Common Stock of ZAIS for the three calendar months ended November 30, 2016 (the “Proposal”). The RSUs and the Cash Amount were both subject to vesting requirements and, collectively, are referred to as the “Election Consideration”. The offer period expired on December 30, 2016.

 

All holders of Class B-0 Units decided to accept the Proposal to receive either RSUs or the Cash Amount. Upon the expiration of the offer period, the holders’ Class B-0 Units were cancelled. For those holders of Class B-0 Units who elected to receive RSUs, ZAIS granted the RSUs under the ZAIS 2015 Stock Incentive Plan (the “2015 Stock Plan”). The RSUs vested on March 17, 2017, the same date that the Class B-0 Units were scheduled to vest. The RSUs entitled the holders to receive ZAIS Class A Common Stock, which was issued, subject to applicable wage withholding requirements, immediately upon the vesting of the RSUs. In consideration of the issuance of such stock by ZAIS to the employees of ZGP’s subsidiary, ZAIS Group, ZGP issued a number of Class A Units to ZAIS equal to the number of shares of stock that were issued to the holders of RSUs. If the B-0 Unit holder elected to receive the Cash Amount, provided the holder remained employed by ZAIS Group or its subsidiaries through the date of vesting, the Cash Amount was paid by ZAIS Group to the holder, subject to applicable wage withholding requirements, on March 22, 2017. See disclosures below for additional information relating to the issuance of the RSUs in exchange for the cancellation of the B-0 Units.

 

 28 

 

 

The number of Class B-0 Units cancelled and Election Consideration provided as a result of the Proposal is as follows:

  

Total number of Class B-0 Units cancelled in substitution for:     
RSUs   899,674 
Cash   133,559 
Total number of Class B-0 Units cancelled   1,033,233 
      
Class B-0 Units not cancelled    
      
Total Cash Amount paid in March 2017 (in thousands)  $256 

 

 The Company accounted for the cancellation of B-0 Units as follows:

 

RSUs Provided as a Replacement for the Cancellation of B-0 Units

 

The Company accounted for the issuance of RSUs as a modification of the award pursuant to ASC 718, “Compensation - Stock Compensation”, treating it as a cancellation of the limited liability company units accompanied by the concurrent grant of RSUs. The Company determined that the fair value of the RSUs and the Class B-0 Units at the modification date were equal and therefore there was no incremental compensation cost required to be recognized. ZAIS completed the amortization of the related compensation expense equally over the two-year vesting period subject to cumulative adjustment for changes in estimated forfeitures at each reporting date.

 

 Cash Provided as a Replacement for the Cancellation of Class B-0 Units

 

The Company accounted for the cash payment to be made in consideration for the cancellation of certain B-0 Units described above as a modification of the award pursuant to ASC 718, “Compensation - Stock Compensation”. However the modification of these awards changed the classification from equity awards to a liability awards. The fair value of the modified award at the time of the modification was approximately $256,000. The Company recognized a liability of approximately $230,000 at December 31, 2016 which reflects the vested amount of the modified award’s measurement date fair value. The remaining fair value of approximately $26,000 was amortized ratably over the remaining vesting period which ended on March 17, 2017.

 

  

Three Months Ended 

June 30,

 
   2017   2016 
   Number of
B-0 Units
   Weighted
Average
Grant Date
Fair Value
per Unit
   Number of
B-0 Units
   Weighted
Average
Grant Date
Fair Value
per Unit
 
Balance at beginning of period      $    1,288,778   $9.40 
                     
Forfeited           (156,565)   9.70 
Balance at end of period      $    1,132,213   $9.36 

 

 29 

 

 

  

Six Months Ended 

June 30,

 
   2017   2016 
   Number of
B-0 Units
   Weighted
Average
Grant Date
Fair Value
per Unit
   Number of
B-0 Units
   Weighted
Average
Grant Date
Fair Value
per Unit
 
Balance at beginning of period      $    1,337,486   $9.67 
                     
Granted           100,000    6.34 
Forfeited           (305,273)   9.70 
Balance at end of period      $    1,132,213   $9.36 

 

The Company incurred compensation expense relating to the Class B-0 Units (including Class B-0 Units cancelled in consideration for the receipt of RSUs or cash) as follows:

 

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
(Dollars in thousands)   (Dollars in thousands) 
2017   2016   2017   2016 
                  
$   $1,296   $1,059   $1,566 

 

The estimated forfeiture rates of Class B-0 Units, including those cancelled in exchange for Class A Common Stock, were as follows:

 

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
(Dollars in thousands)   (Dollars in thousands) 
2017   2016   2017   2016 
                  
 —%    29.6%   —%    29.6%

 

The expense relating to the Class B-0 Units (pre-modification of the award) is included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss).

 

RSUs

 

The Company may grant up to 2,080,637 shares of Class A Common Stock pursuant to the 2015 Stock Plan.

 

Non-employee directors of ZAIS receive RSUs pursuant to the 2015 Stock Plan as a component of compensation for their service as directors of ZAIS. The awards are unvested at the time they are granted and, as such, are not entitled to any dividends or distributions from ZAIS or other material rights until such RSUs vest. The RSUs vest in full on the one-year anniversary of the grant date. Upon vesting ZAIS will issue the recipient shares of Class A Common Stock equal to the number of vested RSUs. In accordance with ASC 718, “Compensation - Stock Compensation”, the Company is measuring the expense associated with these awards based on the fair value on the grant date adjusted for estimated forfeitures. This expense is being amortized equally over the one-year vesting period and adjusted on a cumulative basis for changes in estimated forfeitures at each reporting date. The weighted average grant date fair value of these RSUs is based on the market value of the Company’s shares on the grant date.

 

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On April 21, 2016, the Company issued 30,942 RSUs to the Company’s non-employee directors with a grant date fair value of $3.22 per share. The RSUs vested on April 21, 2017.

 

On November 1, 2016, the Company issued 74,331 RSUs to the Company’s non-employee directors with a grant date fair value of $1.73 per share. The RSUs are scheduled to vest on November 1, 2017.

 

On May 9, 2017, the Company issued 63,219 RSUs to the Company’s non-employee directors with a grant date fair value of $2.19 per share. The RSUs are scheduled to vest on May 9, 2018.

 

Additionally, pursuant to the Proposal (see “Class B-0 Units” above), the Company issued 899,674 RSUs on December 30, 2016. The weighted average grant date fair value of these RSUs is equal to the fair value of the related B-0 Units at the time the units were issued.

 

On March 17, 2017, the 899,674 RSUs granted in connection with the Proposal vested. The fair value of the consideration was $2.1 million based on the closing stock price of the Company’s Class A Common Stock on March 17, 2017 and the gross amount of RSUs that vested. The Company issued 548,923 shares of its Class A Common Stock, on a net basis (to account for applicable wage withholding requirements), to the holders who elected to cancel their Class B-0 Units in substitution for RSUs. The applicable wage withholding requirement of approximately $0.8 million was recorded as a reduction of Additional paid-in-capital and Non-controlling interest in ZGP in the Consolidated Statements of Changes in Equity and Non-controlling Interests.

 

Additionally, ZAIS Group paid the Cash Amount of approximately $256,000 to the holders who elected the Cash Amount (subject to applicable wage withholding requirements) on March 22, 2017.

 

The following table presents the RSU activity for non-employees as well as employees that agreed to the cancellation of their Class B-0 Units:

 

  

Three Months Ended

June 30,

 
   2017   2016 
   Number of
RSUs
   Weighted
Average
Grant Date
Fair Value
per Unit
   Number of
RSUs
   Weighted
Average
Grant Date
Fair Value
per Unit
 
Balance at beginning of period:   105,273   $2.17    30,000   $9.85 
Grants during period to:                    
Non-employee directors   63,219    2.19    30,942    3.22 
Vested   (30,942)   3.22    (30,000)   9.85 
Balance at end of period   137,550   $1.94    30,942   $3.22 

 

  

Six Months Ended

June 30,

 
   2017   2016 
   Number of
RSUs
   Weighted
Average
Grant Date
Fair Value
per Unit
   Number of
RSUs
   Weighted
Average
Grant Date
Fair Value
per Unit
 
Balance at beginning of period:   1,004,947   $8.60    30,000   $9.85 
Grants during period to:                    
Non-employee directors   63,219    2.19    30,942    3.22 
Vested   (930,616)   9.13    (30,000)   9.85 
Balance at end of period   137,550   $1.94    30,942   $3.22 

 

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The Company incurred compensation expense relating to the non-employee RSUs as follows:

 

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$56   $43   $109   $116 

 

 The expense relating to these RSUs is included in Compensation and benefits on the Consolidated Statements of Comprehensive Income (Loss).

 

9. Income Taxes

 

ZAIS is taxable as a corporation for U.S. tax purposes while ZGP and its subsidiaries operate as pass-through entities for U.S. income tax purposes not subject to entity level taxes. Accordingly, the Company’s consolidated financial statements include U.S. federal, state and local income taxes on ZAIS’ allocable share of the consolidated results of operations, as well as taxes payable to jurisdictions outside the U.S related to the foreign subsidiaries.

 

The Company recorded an income tax (benefit) expense of $5,000 and $10,000 for the three months and six months ended June 30, 2017, respectively, related solely to foreign taxes payable to jurisdictions outside the U.S. related to Company’s foreign subsidiaries. The Company recorded income tax expense of $4,000 and $9,000 for the three and six months ended June 30, 2016, respectively, related solely to foreign taxes.

 

As a result of the variations each quarter in the relationship between pre-tax income and income tax expense, the Company utilizes the actual effective tax rate for each interim period being presented to calculate the tax (benefit) or expense. The following is a reconciliation of the U.S. statutory federal income tax to the Company’s effective tax:

 

   Three Months Ended
June 30,
  

Six Months Ended

June 30,

 
   2017   2016   2017   2016 
       (Dollars in thousands)     
                 
Income tax (benefit) expense at the U.S. federal statutory income tax rate  $148    (1,676)   (1,698)   (3,850)
                     
State and local income tax, net of federal benefit   (37)   (242)   (270)   (529)
Foreign tax   5    4    10    9 
Effect of permanent differences   2    56    3    58 
Income attributable to non-controlling interests in Consolidated Funds not subject to tax   (475)   (358)   (750)   (607)
Income attributable to non-controlling interests in ZGP not subject to tax   107    649    814    1,430 
Equity Compensation “Shortfall” DTA Adjustment   (16)        1,932      
Valuation allowance   271    1,571    (31)   3,498 
Total   5    4    10    9 

 

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The Company’s effective tax for the periods presented above includes a rate benefit attributable to the fact that the Company’s subsidiaries operate as limited liability companies and limited partnerships which are treated as pass-through entities for U.S. federal and state income tax purposes. Accordingly, the Company’s consolidated financial statements include U.S. federal, state and local income taxes on the Company’s allocable share of the consolidated results of operations. The tax liability or benefit related to the partnership income or loss not allocable to the Company rests with the equity holders owning such non-controlling interests in ZAIS subsidiaries.

 

For the three and six months ended June 30, 2017 and June 30, 2016, the net effective tax represents the taxes accrued related to the Company’s operations in jurisdictions outside the U.S. as a full valuation allowance has been established for the tax benefit related to U.S. federal, state and local income taxes on the Company’s allocable share of the consolidated results of operations as well as Company’s net operating losses and development stage start-up expenses incurred during the period from its inception and prior to the closing of the Business Combination with ZGP. Additionally, for the three and six months ended June 30, 2017, the net effective tax is impacted due to a shortfall adjustment for equity compensation primarily related to the exchange of the Class B-0 Units discussed in Note 8 – “Compensation”.

 

Deferred income taxes are provided for the effects of temporary differences between the tax basis of an asset or liability and are reported in the Consolidated Statements of Financial Condition. These temporary differences result in taxable or deductible amounts in future years.

 

As of each of June 30, 2017 and December 31, 2016, the Company had total deferred tax assets (“DTA”) of approximately $7.0 million, related to net operating losses and other temporary differences related to the Company’s allocable share of the consolidated results of operations as well as Company’s net operating losses and development stage start-up expenses incurred during the period from its inception and prior to the closing of the Business Combination with ZGP. The Company has established a full valuation allowance on the DTA at June 30, 2017 and December 31, 2016.

 

As of June 30, 2017, the Company has estimated federal and state income tax net operating loss carryforwards of approximately $13.4 million which will expire as follows:

 

   (Dollars in
thousands)
 
2032  $1 
2033   83 
2034   122 
2035   5,990 
2036   1,640 
2037   5,569 
Total  $13,405 

 

As of each reporting date, management considers new evidence, both positive and negative, that could affect its view of the future realization of DTA. As of June 30, 2017, the Company has determined that the most recent management business forecasts do not support the realization of net DTA recorded for the Company. The Company has recorded a book loss for the three and six months ended June 30, 2017 excluding income attributable to Consolidated Funds, and it is anticipated that expenses will continue to exceed revenues in 2017. Although management intends to pursue various initiatives with potential to alter the operating loss trend, there is no specific plan that has been implemented at this point in time that will alter the negative earnings trend.

 

Accordingly, management continues to believe that it is not more likely than not that its DTA will be realized and the Company has continued to maintain full valuation allowance against the DTA at June 30, 2017. The Company has recorded a change in valuation allowance of approximately $271,000 and $(31,000) in the Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2017, respectively, and approximately $1.6 million and $3.5 million for the three and six months ended June 30, 2016 respectively. The Company intends to continue maintaining a full valuation allowance on its deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances.

 

 33 

 

 

The Company does not believe it has any significant uncertain tax positions. Accordingly, the Company did not record any adjustments or recognize interest expense for uncertain tax positions for the three and six months ended June 30, 2017 and June 30, 2016, respectively. In the future, if uncertain tax positions arise, interest and penalties will be accrued and included in Income tax (benefit) expense in the Consolidated Statements of Comprehensive Income (Loss).

 

10. Related Party Transactions

 

ZAIS Managed Entities

 

ZAIS Group offers a range of alternative and traditional investment strategies through the ZAIS Managed Entities. ZAIS Group earns all of its management fee income and incentive income from the ZAIS Managed Entities, which are considered related parties as the Company manages the operations of, and makes investment decisions for, these entities. The Company considers ZAIS Group’s principals, executives, employees and all ZAIS Managed Entities to be affiliates and related parties.

 

ZAIS Group invests in its subsidiaries and some of the ZAIS Managed Entities. Investments in subsidiaries and certain ZAIS Managed Entities that are consolidated are eliminated. Investments in certain ZAIS Managed Entities that are not consolidated are further described in Note 3.

  

ZAIS Group did not charge management fees or earn incentive income on investments made in the ZAIS Managed Entities (excluding CLOs and ZFC REIT) by ZAIS Group’s principals, executives, employees and other related parties. The total amount of investors’ capital balances that are not being charged fees were approximately as follows:

 

June 30,
2017
   December 31,
2016
 
(Dollars in thousands) 
        
$22,934   $21,713 

 

Additionally, certain ZAIS Managed Entities, with existing fee arrangements, have investments representing 100% of the equity tranche of ZAIS CLO 2, Limited (“ZAIS CLO 2”) at June 30, 2017 and December 31, 2016 and ZAIS CLO 1, Limited (“ZAIS CLO 1”) for the period from January 1, 2017 through June 7, 2017 and at December 31, 2016. Therefore, ZAIS Group did not earn management fees or incentive fees from certain ZAIS managed CLOs for the period which certain ZAIS Managed Entities with existing fee arrangements held investments representing 100% of the equity tranche of such CLOs. The total amounts of AUM that are not being charged fees were approximately as follows:

 

June 30,
2017
   December 31,
2016
 
(Dollars in thousands) 
        
$296,452   $560,272 

 

 The amounts due from the ZAIS Managed Entities for Research Costs and other costs paid to vendors by ZAIS on behalf of the ZAIS Managed Entities (the “Other Direct Costs”) are as follows:

 

  

June 30,

2017

  

December 31,

2016

 
   (Dollars in thousands) 
         
Research Costs  $788   $581 
Other Direct Costs   313    117 
Total  $1,101   $698 

 

These amounts are included in Due from related parties in the Consolidated Statements of Financial Condition.

 

 34 

 

 

Consulting Agreements 

 

RQSI, Ltd.

 

Certain affiliates of Mr. Neil Ramsey (“Mr. Ramsey”) are significant stockholders of ZAIS.

 

ZGP entered into a two-year Consulting Agreement (the “Consulting Agreement”) with Mr. Ramsey through RQSI, Ltd., an entity controlled by Mr. Ramsey. Under the terms of the Consulting Agreement, Mr. Ramsey provided consulting services to ZGP, ZAIS Group’s senior management team and ZAIS, from time to time during the 24-month period beginning on the closing of the Business Combination and expiring on March 17, 2017. Mr. Ramsey agreed not to compete against ZGP during the term of the Consulting Agreement, and for two years following its termination. In consideration for his undertakings under the Consulting Agreement, ZGP agreed to pay Mr. Ramsey a consulting fee of $500,000 per annum payable in monthly installments. The Consulting Agreement terminated on March 17, 2017.

 

The Company has recorded the following expense related to the Consulting Agreement:

 

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$   $125   $105   $250 

 

The expense is included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss).

 

There were no amounts payable to Mr. Ramsey pursuant to the Consulting Agreement at June 30, 2017 or December 31, 2016. 

 

ZAIS Group has agreed to use certain statistical data generated by RQSI, Ltd. models. ZAIS Group may use this information for trading futures on behalf of the ZAIS Managed Entities.

 

ZAIS Group entered into a month to month lease agreement with an affiliate of RQSI, Ltd dated February 1, 2016 to occupy space in the Company’s London office. The agreement was terminable upon 30 days’ notice. There was no charge to RQSI, Ltd. or its affiliate for use of the space prior to March 1, 2017. From March 1, 2017 through May 31, 2017, the date the lease was terminated, the monthly rate was 4,167 GBP.

 

Ms. Tracy Rohan

 

ZAIS Group is a party to a consulting agreement with Ms. Tracy Rohan (“Ms. Rohan”), Mr. Zugel’s sister-in-law, pursuant to which Ms. Rohan provides services to ZAIS Group relating to event planning, promotion, web and print branding and related services. Pursuant to the consulting agreement, Ms. Rohan earns 76,000 GBP annually. The Company recognized the following amounts for her services:  

 

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$24   $27   $48   $54 

 

The expense is included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss).

 

 35 

 

 

Amounts payable to Ms. Rohan pursuant to the consulting agreement are as follows:

 

June 30,

2017

  

December 31,

2016

 
(Dollars in thousands) 
$8   $16 

 

Such amounts are included in Other liabilities in the Consolidated Statements of Financial Condition.

 

11. Property and Equipment

 

Property and equipment consist of the following:

 

  

June 30,

2017

  

December 31,

2016

 
   (Dollars in thousands) 
         
Office equipment  $3,246   $3,098 
Leasehold improvements   692    684 
Furniture and fixtures   572    572 
Software   412    409 
    4,922    4,763 
Less accumulated depreciation and amortization   (4,603)   (4,489)
Total  $319   $274 

 

The Company recognized depreciation and amortization expense as follows:

 

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$71   $64   $111   $127 

 

12. Commitments and Contingencies

 

Engagement Agreement with Berkshire Capital

 

On April 22, 2016, the Company entered into an investment banking engagement agreement with Berkshire Capital Securities, LLC (“Berkshire Capital”), an affiliate of Mr. R. Bruce Cameron, a former director of the Company, pursuant to which Berkshire Capital will provide financial advisory services in connection with the Company’s strategic planning. Pursuant to the engagement letter, Berkshire Capital received a $100,000 retainer and is entitled to receive a monthly retainer of $15,000 beyond the initial three month term of the engagement, reimbursements for its expenses and a success fee in the event of covered transactions equal to no more than the greater of $750,000 and 2% of the total consideration paid. 

 

 36 

 

 

The Company incurred the following expenses pursuant to the engagement agreement:

 

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$45   $76   $91   $76 

 

Legal Advisor Agreement

 

On February 27, 2017, ZAIS Group entered into an agreement (the “Legal Advisor Agreement”) with Howard Steinberg, the Company’s former General Counsel, pursuant to which Mr. Steinberg resigned as General Counsel effective March 31, 2017 and was retained as Senior Legal Advisor to the Company effective April 1, 2017. Under the Legal Advisor Agreement, which was approved by the Compensation Committee of the Board of Directors, Mr. Steinberg receives $150,000 per calendar quarter for his services, plus additional compensation of $900 per hour if he is requested to devote more than 20 hours during any week to advising the Company. In addition, under the Legal Advisor Agreement, Mr. Steinberg is entitled to reimbursement of reasonable out-of-pocket expenses incurred in connection with performing services for the Company, an allowance or reimbursement for the reasonable cost of suitable office space in Manhattan should Mr. Steinberg require it, 70% of the premiums for COBRA health and medical insurance coverage for Mr. Steinberg and his spouse paid for by the Company and, after COBRA coverage lapses, up to 70% of the costs of Medicare supplementary health insurance coverage for Mr. Steinberg and his spouse, for as long as he provides legal advisory services to the Company, capped at $3,450 per quarter. Pursuant to the Legal Advisor Agreement, Mr. Steinberg also received a payment of $450,000 on February 28, 2017. The Legal Advisor Agreement is terminable by the Company or Mr. Steinberg on 30 days’ prior written notice. If the Legal Advisor Agreement is terminated by the Company other than due to Mr. Steinberg’s failure to perform services, Mr. Steinberg is entitled to a payment of $300,000.

 

The Company incurred the following expenses pursuant to the Legal Advisor Agreement:

 

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$192   $   $642   $ 

 

Capital Commitments

 

At June 30, 2017 and December 31, 2016, the Company has committed $51.0 million of equity capital to Zephyr A-6, a Consolidated Fund, which has been established to invest in ZAIS Group managed CLOs and thereby satisfy the risk retention requirements of the Dodd-Frank Act. The Company’s cumulative contributions to Zephyr A-6 were as follows:

 

June 30,

2017

  

December 31,

2016

 
(Dollars in thousands) 
        
$26,597   $20,477 

 

There is no assurance that the full commitments will be required to be funded by ZAIS Group or as to the period of time during which these commitments may be required to be funded. ZAIS Group serves as the investment manager to these ZAIS Managed Entities and determines when, and to what extent, capital will be called.

 

In February 2017, ZAIS Group made a $5.0 million commitment to a ZAIS Managed Entity which focuses on investing in non-ZAIS managed CLOs, none of which has been called as of August 14, 2017.

 

 37 

 

 

Lease Obligations

 

ZAIS Group currently leases office space in New Jersey and London under operating lease agreements. On June 9, 2017, ZAIS Group extended its existing lease agreement for its office space in New Jersey until July 2018. On June 5, 2017, ZAIS Group (UK) Limited, the Company’s London subsidiary, provided notice that the lease of its London office premises would terminate on September 7, 2017. On July 26, 2017, ZAIS Group (UK) Limited entered into an agreement to lease office space in London, commencing on September 11, 2017 and which may be cancelled on each anniversary subject to the provision of at least 3 months’ notice. The Company recognizes rent expense related to its operating leases on a straight-line basis over the lease term and is included in General, administrative and other in the Consolidated Statements of Comprehensive Income (Loss). The Company incurred rent expense as follows:

 

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$222   $263   $437   $507 

 

Aggregate future minimum annual rental payments for the period from July 1, 2017 to December 31, 2017 and the period subsequent to December 31, 2017 are approximately as follows:

 

Period  (Dollars in
thousands)
 
      
Six months ended December 31, 2017   310 
      
January 2018 through September 2018   278 

 

Effective September 30, 2016, the Company terminated a portion of its lease and reduced its office space in New Jersey by approximately 2,600 square feet. In connection with the lease termination, the Company paid a lease termination fee of approximately $20,000 pursuant to the terms of the lease.

  

Litigation

 

From time to time, ZAIS Group may become involved in various claims, formal regulatory inquiries and legal actions arising in the ordinary course of business. The Company discloses information regarding such inquiries if disclosure is required pursuant to accounting and financial reporting standards.

 

Other Contingencies

 

In the normal course of business, ZAIS Group enters into contracts that provide a variety of indemnifications. Such contracts include those with certain service providers, brokers and trading counterparties. Any exposure to ZAIS Group under these arrangements could involve future claims that may be made against ZAIS Group. Currently, no such claims exist or are expected to arise and, accordingly, the Company has not accrued any liabilities in connection with such indemnifications.

 

Gain Contingencies

 

In April 2016 the Company received notification from one of its insurance providers that its claim for reimbursement of certain legal and other costs relating to a formal regulatory inquiry had been approved.

 

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The Company had paid approximately $0.02 million and $3,000 during the three months ended June 30, 2017 and June 30, 2016, respectively, and $0.04 million and $0.2 million during the six months ended June 30, 2017 and June 30, 2016, respectively, for legal and other costs incurred in excess of its insurance deductible.

 

The cumulative insurance reimbursements that the Company has received through June 30, 2017 and December 31, 2016 were approximately $0.9 million and $0.9 million, respectively. Pursuant to the guidance under ASC 450, "Contingencies – Gain Contingencies”, approximately $0.55 million of the insurance reimbursements received was recorded in Other income (expense) in the Consolidated Statements of Comprehensive Income (Loss) for the six months ended June 30, 2016 for the portion that related to 2015.

 

At June 30, 2017 and December 31, 2016, the remaining amount submitted to the insurance provider for reimbursement was approximately $0.02 million and $0.02 million, respectively and is included in Other assets in the Consolidated Statements of Financial Condition.

 

13. Segment Reporting

 

The investment management segment is currently the Company’s only reportable segment, and represents the Company’s core business, as substantially all of the Company’s operations are conducted through this segment. The investment management segment provides investment advisory and asset management services to the ZAIS Managed Entities.

 

14. Stockholders’ Equity

 

Preferred Stock

 

The Company is authorized to issue 2,000,000 shares of preferred stock with a par value of $0.0001 per share with such designation, rights and preferences as may be determined time to time by the Board of Directors. No shares of preferred stock have been issued or are outstanding.

 

Class A Common Stock

 

The Company is authorized to issue 180,000,000 shares of Class A Common Stock with a par value of $0.0001 per share. Holders of record of Class A Common Stock are entitled to one vote for each share held on all matters to be voted on by stockholders.

 

The Company issued the following Class A Common Stock related to RSUs which vested:

 

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
2017   2016   2017   2016 
                  
 30,942    30,000    579,865    30,000 

 

Class B Common Stock

 

The Company is authorized to issue 20,000,000 shares of Class B Common Stock with a par value of $0.000001 per share. The Class B Common Stock has no economic rights and therefore is not considered participating securities for purposes of allocation of net income (loss). Holders of record of Class B Common Stock are entitled to ten votes for each share held on all matters to be voted on by stockholders.

 

At June 30, 2017 and December 31, 2016, 20,000,000 shares of Class B Common Stock are held by an irrevocable voting trust of which Mr. Zugel is the sole trustee (the “ZGH Class B Voting Trust”). There were no shares of Class B Common Stock issued during the three or six months ended June 30, 2017 or June 30, 2016. Consequently, in his capacity as trustee of the ZGH Class B Voting Trust, Mr. Zugel has effective voting control over the election of directors and generally on all other matters submitted for approval by the Company’s stockholders.

 

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Class A Units

 

At June 30, 2017 and December 31, 2016, ZAIS’ ownership of the Class A Units was 67.4% and 66.5%, respectively. The remaining Class A Units of ZGP are held by the ZGP Founder Members.

 

During the first five years following the closing of the Business Combination, ZGP will release up to an additional 2,800,000 Class A Units to the ZGP Founder Members if the sum of the average per share closing price over any 20 trading-day period of the Class A Common Stock plus cumulative dividends paid on the Class A Common Stock between the closing of the Business Combination and the day prior to such 20 trading-day period meets or exceeds specified thresholds, ranging from $12.50 to $21.50.

 

There were 30,942 Class A Units issued to ZAIS during the three months ended June 30, 2017 and 30,000 Class A Units issued during the three months ended June 30, 2016. There were 579,865 Class A Units issued to ZAIS during the six months ended June 30, 2017 and 30,000 Class A Units issued during the six months ended June 30, 2016.

 

Class B Units

 

ZGP may issue up to 6,800,000 Class B units (“Class B Units”) at any time during the five year period following the closing of the Business Combination, a portion of which (the Class B-0 Units) were awarded but subsequently cancelled (see Note 8 – “Compensation”). These units are still available for re-issuance. The remaining 5,200,000 Class B Units are designated as Class B-1, Class B-2, Class B-3 and Class B-4 Units (together the “Additional Employee Units”), which, once issued, vest in three equal installments only if the Class A Common Stock of ZAIS achieves certain average closing price thresholds within five years after the closing of the Business Combination ranging from $12.50 to $21.50 as follows: one-third of such award vests upon achieving the applicable threshold, one-third of such award vests upon the first anniversary of such achievement and the final one-third of such award vests upon the second anniversary of such achievement, unless otherwise provided in the restricted unit agreement granting the Class B unit. Although the Class B Units are outstanding when issued, the Class B Units are not entitled to any distributions from ZGP (and thus will not participate in, or be allocated any, income or loss) or other material rights until such Class B Units vest.

 

Subject to certain restrictions, the ZGP Founder Members’ Class A Units and, if any, all of the vested Class B Units (but not any unvested Class B Units) may be exchanged for shares of Class A Common Stock of ZAIS on a one-for-one basis (subject to certain, if any, adjustments to the exchange ratio) or, at ZAIS’s option, cash or a combination of Class A Common Stock and cash, pursuant to the Exchange Agreement that ZAIS entered into with ZGP, the ZGP Founder Members and the other parties thereto.

 

There were no Class B-1, Class B-2, Class B-3 or Class B-4 Units awarded for the three or six months ended June 30, 2017 or June 30, 2016 and no Class B Units currently are issued and outstanding.

 

On December 1, 2016, the Board of Directors authorized ZGP to offer the employees who agreed to the cancellation of their unvested Class B-0 Units the right to receive in substitution for the cancellation of their Class B-0 Units, at the holder’s option, either (a) RSUs of ZAIS, on a one-for-one basis, or (b) an amount of cash per Class B-0 Unit cancelled (See Note 8 – “Compensation”). Both were subject to vesting requirements.

 

15. Earnings Per Share

 

Shares of Class B Common Stock have no impact on the calculation of consolidated net income (loss) per share of Class A Common Stock as holders of Class B Common Stock do not participate in net income or dividends, and thus, are not participating securities.

 

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The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted earnings per share:

 

   Three Months Ended
June 30,
  

Six Months Ended

June 30,

 
   2017   2016   2017   2016 
   (Dollars in thousands, except shares and per share data) 
Numerator:                    
Consolidated Net Income (Loss), net of tax, attributable to ZAIS Group Holdings, Inc. Class A common stockholders (Basic)  $(652)  $(4,076)  $(4,814)  $(8,910)
Effect of dilutive securities:                    
Consolidated Net Income (Loss), net of tax, attributable to non-controlling interests in ZGP   (315)   (1,911)   (2,398)   (4,210)
Less: Consolidated Net (Income) Loss, net of tax, attributable to ZAIS REIT Management Class B interests (1)       (142)       (284)
Income tax (benefit) expense (2)                
Consolidated Net Income (Loss), net of tax, attributable to stockholders, after effect of dilutive securities  $(967)  $(6,129)  $(7,212)  $(13,404)
Denominator:                    
Weighted average number of shares of Class A Common Stock   14,473,642    13,892,016    14,231,320    13,881,466 
Effect of dilutive securities:                    
Weighted average number of Class A Units   7,000,000    7,000,000    7,000,000    7,000,000 
Dilutive number of Class B-0 Units and RSUs (3)                
Diluted weighted average shares outstanding (4)   21,473,642    20,892,016    21,231,320    20,881,466 
Consolidated Net Income (Loss), net of tax, per Class A common share – Basic  $(0.05)  $(0.29)  $(0.34)  $(0.64)
Consolidated Net Income (Loss), net of tax, per Class A common share – Diluted  $(0.05)  $(0.29)  $(0.34)  $(0.64)

 

(1)   Amount represents portion of the management fee income received from ZFC REIT that was payable to holders of Class B interests in ZAIS REIT Management.
(2)   Income tax (benefit) expense is calculated using an assumed tax rate of 41.73% and 38.56% for the three months ended June 30, 2017 and June 30, 2016, respectively, and (0.64)% and 39.29% for the six months ended June 30, 2017 and June 30, 2016, respectively, which is fully offset by a 100% valuation allowance in each year. See Note 9 – “Income Taxes” for details surrounding income taxes.
(3)   The treasury stock method is used to calculate incremental Class A common shares on potentially dilutive Class A common shares resulting from unvested Class B-0 Units granted in connection with and subsequent to the Business Combination and unvested RSUs granted to non-employee directors of ZAIS and employees of ZAIS Group. These Class B-0 Units and RSUs are anti-dilutive and, consequently, have been excluded from the computation of diluted weighted average shares outstanding.
(4)   Number of diluted shares outstanding takes into account non-controlling interests of ZGP that may be exchanged for Class A Common Stock under certain circumstances.

 

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16. Supplemental Financial Information

 

The following supplemental financial information illustrates the consolidating effects of the Consolidated Funds on the Company’s financial condition and results of operations:

 

   June 30, 2017 
   ZAIS   Consolidated
Funds
   Eliminations   Consolidated 
   ( Dollars in thousands ) 
Assets                    
Cash and cash equivalents  $16,970            16,970 
Income and fees receivable   2,198        (329)   1,869 
Investments in affiliates, at fair value   42,986        (32,698)   10,288 
Due from related parties   1,101            1,101 
Property and equipment, net   319            319 
Prepaid expenses   1,907            1,907 
Other assets   385            385 
Assets of Consolidated Funds                    
Cash and cash equivalents       13,416        13,416 
Investments, at fair value       459,416    (12,709)   446,707 
Due from broker       12,095        12,095 
Other assets       1,320    (313)   1,007 
Total Assets  $65,866    486,247    (46,049)   506,064 
Liabilities and Equity                    
Liabilities                    
Compensation payable  $4,594            4,594 
Due to related parties   31            31 
Fees payable   289        (289)    
Other liabilities   1,147            1,147 
Liabilities of Consolidated Funds                    
Notes payable of Consolidated CLO       397,229    (12,710)   384,519 
Due to broker       21,974        21,974 
Other liabilities       2,930    (351)   2,579 
Total Liabilities   6,061    422,133    (13,350)   414,844 
                     
Commitments and Contingencies (Note 12)                    
                     
Equity                    
Preferred Stock                
Class A Common Stock   1            1 
Class B Common Stock                
Additional paid-in-capital   64,210            64,210 
Retained earnings (Accumulated deficit)   (23,779)           (23,779)
Accumulated  other comprehensive income (loss)   (44)           (44)
Total stockholders’ equity, ZAIS Group Holdings, Inc.   40,388            40,388 
Non-controlling interests in ZAIS Group Parent, LLC   19,417            19,417 
Non-controlling interests in Consolidated Funds       64,114    (32,699)   31,415 
Total Equity   59,805    64,114    (32,699)   91,220 
Total Liabilities and Equity  $65,866    486,247    (46,049)   506,064 

 

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   December 31, 2016 
   ZAIS   Consolidated
Funds
   Eliminations   Consolidated 
   ( Dollars in thousands ) 
Assets                    
Cash and cash equivalents  $38,712   $   $   $38,712 
Income and fees receivable   8,805            8,805 
Investments in affiliates, at fair value   29,554        (24,281)   5,273 
Due from related parties   734            734 
Property and equipment, net   274            274 
Prepaid expenses   906            906 
Other assets   348            348 
Assets of Consolidated Funds                    
Cash and cash equivalents       37,080        37,080 
Investments, at fair value       423,871    (19,506)   404,365 
Due from broker       16,438        16,438 
Other assets       1,254    (44)   1,210 
Total Assets  $79,333   $478,643   $(43,831)  $514,145 
Liabilities and Equity                    
Liabilities                    
Notes payable  $1,263   $   $   $1,263 
Compensation payable   7,836            7,836 
Due to related parties   31            31 
Fees payable   2,439            2,439 
Other liabilities   1,127            1,127 
Liabilities of Consolidated Funds                    
Notes payable of Consolidated CLO       404,407    (19,506)   384,901 
Due to broker       24,462        24,462 
Other liabilities       2,165    (44)   2,121 
Total Liabilities   12,696    431,034    (19,550)   424,180 
                     
Commitments and Contingencies (Note 12)                    
                     
Equity                    
Preferred Stock                
Class A Common Stock   1            1 
Class B Common Stock                
Additional paid-in-capital   63,413            63,413 
Retained earnings (Accumulated deficit)   (18,965)           (18,965)
Accumulated  other comprehensive income (loss)   (70)           (70)
Total stockholders’ equity, ZAIS Group Holdings, Inc.   44,379            44,379 
Non-controlling interests in ZAIS Group Parent, LLC   22,258            22,258 
Non-controlling interests in Consolidated Funds       47,609    (24,281)   23,328